Stocks still too pricey

Billionaire money manager Warren Buffett is known as the “oracle of Omaha” to millions of investors. When he publishes his annual letter to shareholders of his Berkshire Hathaway Corporation, the whole world pays attention.

The latest Buffett bulletin appeared in early March and it contained some sobering news for investors. Despite the terrible beating that stocks have received in recent years, the Master of Money still thinks they’re too pricey and he’s not buying any. Instead, he’s sinking a sizeable fortune into high-yield bonds, or “junk bonds” as they are sometimes called, not always accurately. Buffett sees greater potential profit there, with less risk.

High-yield bonds higher risk
High-yield bonds are usually lower grade corporate issues, although debt securities issued by less developed countries also fall into the category. They have traditionally been considered as higher risk, because of the danger of default. Companies can go into bankruptcy, leaving their bond holders with nothing. That’s not going to happen to government bonds issued by countries like Canada and the U.S., which is why they pay lower interest rates/P>

However, holding a diversified portfolio of high-yield bonds reduces the overall risk and several mutual funds now specialize in this area of investing.

T-Birds offer attractive rates
For a specific example of a high-yield bond, let’s look at a recent issue from Ford Credit Canada. Recently, a correspondent wrote to ask for my view on these bonds, which are called “T-Birds” in the market. He explained the details as follows:

“They come in three versions: 2-year notes pay 6.3 per cent, 3-year notes give you 6.7 per cent, 5-year notes pay 7.4 per cent. They come with a monthly-pay feature. You can get on board for as little as $1,000. The posted rates change weekly. An advisor I contacted said they were akin to corporate bonds with the commission/fee built into the price like regular bonds. A spokesman for Ford Credit said: ‘The whole idea is to give the retail investor an opportunity to buy a credit they otherwise would never get a chance to.’ What is your opinion on this product?”

Look at credit ratings
For starters, the first thing you have to look at with any corporate bond or note is the credit rating. As a general rule, the higher the interest rate, the lower the rating. That’s because corporations with lower ratings must pay more to borrow money.

The rates being offered by the T-Birds are attractive, although not the highest available to corporate bond investors by any means. That’s because Ford Credit Canada receives a decent, although not outstanding, rating from the bond rating agencies.

Next page: What’s a satisfactory rating?

What’s a satisfactory rating?
Dominion Bond Rating Service, for example, rates their short-term paper as R-1 (low), with a stable outlook. This is explained in their methodology notes as being a “satisfactory” rating. Longer-term debt receives an A (low) rating, with a negative outlook. Again, this is described as “satisfactory”. However, the negative outlook suggests the possibility of a rating cut in the future. The next level down is BBB, which DBRS describes as “adequate credit rating” with the notation: “Protection of interest and principal is considered adequate, but the entity is more susceptible to adverse changes in financial and economic conditions, or there may be other adversities present which reduce the strength of the entity and its rated securities.”

You can check the ratings of many credit issuers at the DBRS site. Go to http://www.dbrs.com

It’s important to remember that other agencies may take differing views of the same company. The best way to obtain an overview of the credit status of any issuer is to ask your broker to see if the firm’s bond desk has a summary available that you can check.

The bottom line in this case is that T-Birds look attractive and the risk level is acceptable in relation to the rates offered. However, before you decide on any corporate issue you should ask your broker to review other options offering similar returns for comparable maturities to ensure you are getting the best buy for your money.

If you’re interested in this type of bond but don’t want to make the selection yourself, consider a mutual fund. There are more than two dozen high-yield bond funds now available including some no-load entries like the TD High Yield Income Fund. Do some research or ask a financial advisor for a recommendation.

Gordon Pape is launching a new e-mail newsletter especially for income-oriented investors. Full details at http://www.buildingwealth.ca/promotion/50plusproducts.htm