Add Some Yield With Carefully Selected 10-Year Corporate Bonds

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Includes: DVMT, KSS, LYG, SAN, SIR
by: John Gerard Lewis

Summary

You can get 4%-5% yields from investment-grade corporate bonds with maturities of about 10 years.

But Triple-B corporates can deteriorate and become Triple-Bad, so be careful.

Buy carefully-selected 8- to 10-year, BBB corporate bonds only from issuers who are solid and liquid.

A fifth of my fixed-income portfolio consists of individual corporate bonds rated BBB- to BBB+ when bought. These are considered "lower medium grade," and because the rest is in very short-term funds and A-rated corporates, the BBBs comprise the "risk" allocation, if you can call it that - the mitigating measures I take significantly reduce the chance that one of my selections will go devastatingly south, although they don't eliminate it.

Some time back, I read an article wherein the author, recommending various corporate bonds, issued a wholly nebulous and ill-considered maxim: "BBB is fine."

Well, fine for what and for whom? "Fine" for many bond investors is an effective guarantee that they're going to get all of their money back at maturity. Even a AAA-rated corporate bond doesn't guarantee that.

Triple-B might well be fine, but it could end up Triple-Bad. Unfortunate things sometimes happen to companies, and that BBB can precipitously become a CCC. Hence, my mitigating measures: mostly buying bonds of seven-year maximum maturity and no worse than a BBB- rating from Standard & Poor's and Fitch, and no worse than Baa3 from Moody's. A lower rating speaks for itself: it's non-investment grade.

(This is not to say that I don't sometimes take a flyer on a calculated speculation, but only for the tiniest "percent of a percent of a percent" of my portfolio, knowing full well that it could tank to zero.)

Even with this self-imposed stricture, I'm additionally careful. If I think, even subjectively, that the rating could be too optimistic (e.g., the industry is too fluid, such as technology), I'll avoid the issue. I invest in bonds to depart from such vagaries.

So why invest in corporates at all when Treasurys and CDs federally guarantee the return of your money?

Answer: To make more money. If you have sufficient financial assets, it's not imprudent to carefully apportion some to higher-yielding, fixed-income securities that the issuer promises to return to you in full. That five-year Treasury paying you 1.2% is going to let you sleep well, but you can also be comfortable with a diversified set of well-chosen five-year BBB corporates yielding 2%-3%.

OK, but can you get 4%-5% somehow? Sure, if you extend your time horizon to a decade. Would you be willing to go out that far with a corporate bond?

For me, it would be only for a small allocation. Just 6% of my fixed-income allocation is in individual corporate bonds of more than seven years' maturity, and those are limited to established "name" issuers like GE Global Insurance Holding, Citicorp, Georgia Pacific and Wachovia. However, if I were to consider some longer-term corporates today, to improve upon the 10-year Treasury's 1.8% yield, I'd look favorably upon these:

- EMC Corp.'s 3.375s due 2023, yield to maturity 6.2%, rated A1 by Moody's, A by S&P (cusip: 268648AN2). Yes, EMC is a data storage company that's tech-related, but the A1 and A ratings on a remaining term of this duration are persuasive.

- Pemex Project Funding Master Trust's 8.625s due 2023, YTM 5.5%, Baa3/BBB+ (cusip: 706451BC4). This issue is not guaranteed by the Mexican government, but the fact remains that Pemex is the Mexican state-owned petroleum company.

- Santander Issuances S.A. Unipersonal's 5.179s due 2025, YTM 5%, A3/BBB (cusip: 80281TAE8). I bought some Santander bonds in 2012 when their Moody's rating was Baa3. The rating for this issue is better.

- May Department Stores's 7.6s due 2025, YTM 4.2%, Baa2/BBB (cusip: 577778AZ6). May has long been part of Macy's, which investor David Einhorn says has a "healthy" balance sheet and which analysts see growing in the mid-single digits over the next five years.

- Lloyd's Banking Group PLC's 4.65s due 2026, YTM 4.2%, Baa2/BBB- (and rated A- by Fitch) (cusip: 53944VAH2). Analysts rate the bank's stock "outperform" and expect a near doubling of the dividend in the next 12 months.

- Nationsbank's 4.25s due 2025, YTM 4.2%, Baa3/BBB (and rated A- by Fitch) (cusip: 638585AP4). Nationsbank became part of Bank of America during the industry's merger mania. Bank of America has strong liquidity and is a systemically important bank.

- Select Income REIT's 4.5s due 2025, YTM 4.6%, Baa2/BBB (cusip: 81618TAC4). The issuer, which owns and manages office and industrial real estate, has strong liquidity.

- Lazard LLC's 3.75s due 2025, YTM 4%, Ba1/A- (cusip: 52107QAG0). Lazard has a strong M&A business and maintains a liquid balance sheet.

- Kohl's' 4.25s due 2025, YTM 4.2%, Baa2/BBB (cusip: 500255AU8). Kohl's has excellent liquidity and a long-term record of successful retail merchandising.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Yields are approximate as of May 4, 2016. The author owns bonds of Bank of America and EMC Corp.