Attractive Rates, Little Risk With Medium-Investment-Grade Corporates

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Includes: DO, DVMT, ERJ
by: John Gerard Lewis

Summary

Investment-grade corporate bond yields provide a worthwhile advantage over those of Treasurys.

Investment-grade corporate bonds rarely end up in default.

Some 5-year investment-grade corporates offer yields of 4-5%.

I love medium-investment-grade corporate bonds, even if they're lower-medium grade. They're quality securities that, using a five-year maturity as an example, can provide up to a 350-basis point advantage over Treasurys.

Of course, they're not as "safe" as Treasurys, but investment-grade corporates almost never end up in default. The failure rate of even non-investment grade (junk) corporates was just 2.4% as of July, according to Moody's Investment Service. I'd almost never consider buying junk unless it was for the tiniest sliver of my bond portfolio, less than 1%, and only if the maturity was less than a couple of years. But if you're looking to grow your portfolio with interest income, without subjecting it to much default risk or the vagaries of stock market movements, selected medium-investment-grade corporates will meet your needs.

Now, let's be clear - we're not talking here about corporate bond funds, which are subject to looming interest rate escalation, commencing, perhaps, as soon as December. A bond fund (except for defined-maturity exchange traded funds, such as those offered by Guggenheim) has no date-certain maturity, so it's eminently vulnerable to the damage that rising rates will wreak on invested capital. We're talking about individual corporate bonds, which, if held to maturity, will almost certainly return everything promised at the outset: the specified yield to maturity (YTM) plus par value.

A notable caveat: This doesn't necessarily mean that you'll get all of your invested capital back if you buy the bond at a price above par value. That practice can be especially dangerous if you buy a callable bond above par, because your accumulated interest may not cover the price difference if it's called. Therefore, be sure that you're satisfied with any callable bond's "yield to worst" (YTW) percentage before buying it at a premium.

(For our purposes, "yield to worst" is the lowest possible yield that can be received, even if it's called at some point, on a bond that doesn't default.)

With those rudiments out of the way, let's look at some attractive opportunities.

In mid-October, I bought three issues with five-year maturities, one of which was the EMC Corp. (EMC) 2.65%, maturing June 1, 2020 (cusip: 268648AQ5). It sports an upper-medium grade rating of A1 by Moody's (S&P: A1), and was nonetheless available at an impressive YTM of over 5%. It is callable, but was bought well below par, and was still priced low, at about $91, as recently as October 30.

I also bought the Diamond Offshore Drilling (NYSE:DO) 5.875%, maturing May 1, 2019 (cusip: 25271CAK8). Moody's rates it Baa2 (S&P: BBB+). It, too, is callable, but the bond had an attractive yield-to-worst of 3.96% at the time of purchase.

And I also bought the callable Embraer Overseas (NYSE:ERJ) 6.375%, due January 15, 2020 (cusip: 29081YAC0), which had a yield to worst of about 3.88% at purchase. It gets lower-medium grade ratings of Baa3 from Moody's and BBB from S&P.

Other five-year investment-grade corporates with YTMs (or YTWs) of 3-4% are available from such familiar names as Xerox (NYSE:XRX), Wyndham Worldwide (NYSE:WYN) and Dun & Bradstreet Corp. (NYSE:DNB).

Disclosure: I am/we are long BONDS OF EMC CORP, DIAMOND OFFSHORE DRILLING, EMBRAER OVERSEAS, AND XEROX.

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.