Professionals Often Stumble With Corporate Bonds

 Professionals in the financial industry constantly get the bond

market wrong. Note: I’m referring to so-called experts, not amateurs.

                       

They make up well over 80% of the market so they should know

better. And the media are usually also in error, when reporting about them.

                       

At the first sign of economic problems, there is talk about corporate defaults and the effect on the bond market. How bond prices are bound to fall because of the risk of possible defaults. And with that talk, the bond market weakens and prices do fall.

                       

But remember: The possibility of default is very quickly factored into bond prices. And the lower the price, the higher the yield, as a direct relationship.

                       

Furthermore, the media hardly ever discuss how you can avoid loss, along with any inflation hit, with proper use of bond duration. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

The Fed and its Humphrey-Hawkins Conflict of Interest

Independent-minded economists have always come to the Fed’s defense, in its attempt to keep the Federal Reserve as free from politics as possible.

                       

But the Dodd-Frank Act has made the Fed less independent of the executive branch of government.

                       

Despite the logic for the Fed’s independence, Congress itself always has wanted to impose some influence. It has to an extent. Since 1978 the Fed has had to enforce the Full Employment and Balanced Growth Act, known as Humphrey-Hawkins. That conflicts with the Fed’s stated currency/inflation activity.

                       

The Humphrey-Hawkins Full Employment Act enforcement creates an inflating bias, and not one of dollar stability; so there is always a conflict of interest. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

When Do You Sell Your Mutual Fund?

I never recommend managed mutual funds for several reasons, including high cost and their too-often inability to emulate indexes. Moreover, managements change and you never know who really is overlooking your assets.

                       

What if the fund is not doing well? That does not mean an automatic sale. Market conditions may be the cause and not management inability.

                       

The major consideration should be fund cost because that is the only factor you can truly control. All other factors are well beyond your possible knowledge. Cost is a huge factor in fund success. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

Credit Rating Agency Accuracy

                       

Credit rating agencies are generally accurate but the divisions that rated sub-prime mortgages were certainly not up to par at the major agencies.

                       

One way to solve the lack of any problems we may have had with credit ratings in the past, is to allow competition among such services.

                       

Why not allow any company who feels qualified to register as a ratings analyst? Today, a small handful has a government monopoly.

                   

If a company can show the Securities and Exchange Commission that it has qualified analysts and capability to evaluate bonds and other securities, why not have a license?

                       

Another consideration: Do credit rating companies have First Amendment free speech immunity? Courts have ruled they have but plaintiff lawyers are always on the prowl. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

Why Buy Managed Mutual Funds?

 I have always commented that indexed mutual funds or exchange traded funds ( ETFs), are better than managed funds. They usually outperform them, and at lower cost. Moreover, the lower the fund cost, the more return an investor will get over the years.

                                       

This question also will come up when a managed mutual fund you may have gets merged into another. These mergers are usually done for either or both of two reasons. To get economy of scale. Or, more often, to hide losing records. In most instances, index funds or exchange traded funds are always a better investment choice. 

Also, don’t attempt to trade managed funds on relatively short term performance. Besides, their internal managements generally change constantly. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

Duration Principles Can Apply to Stocks?

I’m repeating last month’s lesson about duration principle investing, as it may be applied to stocks.(See yesterday's blog on bonds.)

I have in the past discussed important rules behind bond duration, which include the need to reinvest the periodic dividends of funds in which the bonds are held.

There is a somewhat similar principle with stocks that have an assured high income.

REITs are one example: If high periodic returns are reinvested in the same entity, you get a similar effect. Such purchases help mitigate risk and reduce average costs of long-term holdings; hit-and-miss market-timing is avoided. (See the Earl J.Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)

Repeating a Bond Investment Lesson

It’s important to repeat this lesson about bond investing because so much information being offered about is so misleading.

Too many financial “experts” flunk bond market basics. They constantly have an unwarranted fear of the adverse effects of higher interest rates on individual bond prices and values. 

Fact: Very few investors buy outright, individual bonds of any maturity, They invest, instead, in convenient, low- cost, fully diversified, mutual funds or ETFs.Therefore, the bulk of so-called expert comments on individual bond purchases and holdings don’t apply.

Fact: For the most part, bond fund owners reinvest their periodic dividends.This is impractical and usually impossible for individual bond buyers to accomplish.

Fact: While it’s true that bond prices fall when interest rates rise, and bond prices rise as interest rates fall, these effects can be modified by duration and reinvestment principles. Duration explains why shorter-term bonds are not affected as much by interest rate movements as are longer-term bonds.

Fact: More important: Bond mutual fund investors who are aware of duration principles need not be hurt over the long term by interest rate moves; they can actually prosper when interest rates go up, with duration rule usage. .

Fact: A bond holder is a lender. The higher interest rates go, the better off that lender is, provided he or she uses duration and reinvestment principles. And sticks to a plan of how long the bond fund is to be kept.

Note: Bond funds usually list their duration numbers. Look for, or ask if they’re available for funds you seek.If not, approximate the figure to an extent by assuming that the shorter-term the bond portfolio maturity, the smaller the fund’s average duration.

The reinvestment solution: The bond investor who reinvests dividends then holds the key to better performance. He should hold the fund longer than the stated duration period of that fund. If his intended investment period is more than 4 years, for example, it will be profitable to hold a bond fund with duration of at least 4 years. Long-term bond fund investors are always ahead in this game.

Fact: Experts love to bring up the question of credit defaults when evaluating bonds. But here again, pundits generally generate more bluster than thought; the defaults rate is always built into the market price of a well- diversified fund. So higher defaults are offset by commensurate higher rates.

All these facts ruin arguments pundits have concerning values of individually-bought, non-in-kind, non- reinvested earnings, that apply to rates or interest-effected changes and looming inflation. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)