Monday, January 5, 2009

Investment Process Part II: Bonds and Bond Like Investments

I am not a professional investor.  I am a professional but at another occupation.  Investing is not my job, more of an avocation along with many other interests. I have never held a job in the securities industry and never will.  Over the years I have talked to a few brokers, not as their customer, but just to see how much they really know-not much to be frank.  I am sure that I will find one some day that knows more than me or at least has better judgment.  (by the way, how did that manager at Magellan do last year?).  When that day comes, I may turn loose a few dollars of my capital, take advantage of their wisdom and experience, but nonetheless continue to research myself every recommendation made before allowing the broker to deploy any capital or touch a single button. This day will never come. I would be interested in talking to someone who spends more time researching securities than talking on the phone or trying to sell customers a product.  Maybe some may read a prospectus for a bond, or glance at it, but I believe that most of them do not before recommending it. How many received a call from a broker trying to sell them some new issue of preferred stock, like one from Fannie Mae sold at $25 in 2007 , maybe it was one from 2007 or early 2008 when they were already running into trouble.

Those who are familiar with my blog and the emails prior to the onset of these public posts would at least ask that broker fundamental questions about the security: (1) has the broker read the prospectus (hang up if the answer is no); (2) is the dividend cumulative (if he does know what cumulative means, is there another broker in the office); (3) is the security perpetual (never good) or does it have a maturity date and if so, when is it (more than 20 years, then ask yourself what are you doing?); (4) what rights does the issuer have to defer the dividend; (5) are there any tax issues mentioned in the prospectus that you need to know about now; (6) what is the seniority of the security;  (7) what is the broker's opinion on the credit of the issuer and how much is the issuer at risk for a default (always crucial); (8) how does the security fit into the carefully thought out asset allocation plan that you already have;  (9) is there more than one way to make money from it, (e.g. selling at a discount);  (10) what are the alternatives available for better or less risky credits and (11) lastly, while I could think of more, I would just add what is your exit strategy for both profit and loss. And those questions would only be asked to a broker who had proven to be very much on the ball, and by an individual who does not have five minutes to check  the information online at the SEC. There is no excuse not to check.  This is serious business for serious people. I have of course not surveyed all brokers.  I do not use brokers. But if anyone finds one that can discuss those issues with a great deal of knowledge, let me know. 

 With the internet, it is extremely easy for anyone to answer these questions online without relying on a broker, and I certainly would not rely on anyone to convey to me this kind of critical information. In my posts I will provide links to the applicable bond or bond like investments that I buy. This is not for my amusement since it takes time to do it. A reader of these posts may already  know these questions to ask themselves when viewing the information firsthand.    

The process that I describe was made possible by the internet. Now, I can easily download and store the prospectus of every TC and preferred stock that I own or that I am actively considering buying. There is no excuse not to do it given its ease, and no excuse not to do it even if you rely on a broker or a financial advisor.   

For a TC, the prospectus usually but not always includes information about the status and priority of the security, that is whether the underlying bond is a senior bond or some junior security. Sometimes I have to go to the prospectus for the underlying bond to find out the needed information, and my files contain the underlying bond prospectus.  Knowing the priority is always the very first question to know with certainty since it can be critical in the event of a bankruptcy. If it some junior bond issued by a bank, that is important to know. If it is a senior bond, then you need to know how much secured debt the company has which can only been done by taking the time to do the research.  You always look up the seniority chain.  I doubt that many brokers could answer too many questions about a particular bond, but someone who is really an experienced investor these days knows to look and how to look. The information can be found in filings with the SEC. Many companies may have a lot of senior debt and a much lesser amount of secured debt. A REIT, on the other hand, may have most of their properties mortgaged and this is important to know. That secured debt comes first.  Then you need to know whether the secured debt is recourse or non-recourse. It is much better for the senior bond holder to have the secured debt non-recourse to the company, which simply means the lender can only look to the security in case of default.  I talked briefly about this issue at it related to Glimcher Realty. In other words, you want to know as much about any debt senior to the bond that you are considering to purchase.  If you do not want to do that kind of inquiry yourself, then you only increase the odds of failure, probably multiple failures extending for however long you have been an investor, and failure can occur easily enough for an experienced hand actually following a thorough research process. 

Once all of  this basic material is gathered, read, and digested, first reading the prospectus which can not never be sloughed off, then determining the status of the other debt and most importantly the maturity schedules of that other debt, then you can now consider issues that relate more to evaluating the company as a common shareholder would do, reading reports about its business and operations, its history, earnings, interest coverage, and other factors. But the purpose is not to decide whether the business is worth an equity investment, based on its price, future prospects, earnings growth, PEG, Price to Sales but simply can this company pay me interest on its debt now and for the foreseeable future.  Sometimes the answer is yes and sometimes the answer is maybe not.  DKR is a maybe not buy of mine.  It was just hard to turn down a 100% a year but I am no fool.  I know that there is danger and it might be my first total loss.  I can take steps to try and mitigate the loss but there is always the Black Swan event lurking outside my door somewhere and maybe DKR will be my first one. This does not end the process. Now, you have to decide if, when and how much to pay and to risk. Most of my mistakes could probably be characterized as being too cautious and not risking enough given my ability to accept large losses.  But I have survived and prospered doing it my way and I have no desire to change now. (I will top out on a particular bond issuer at $10,000 and no more under any circumstances)

I try to be sensitive to credit issues. So far, I have avoided  Enron, Worldcom, Lehman, and every other blow up credit.  Sooner or later, I will misjudge the situation as I came close to doing with a Lehman floater, discussed in a prior post as an example of dangers that are always omnipresent particularly with junior securities.  Once the position is taken in a bond or preferred stock, it can not be out of sight, out of mind. The risk of default has to be continuously monitored. I have three positions now in REIT cumulative preferred stocks that are high risk.  Even though my position is insignificant, I decide every day whether to keep them or let them go. That is very tight monitor.  I do not pay that much daily attention to a senior bond issued by a seasoned investment grade company.  But, even with those, I will read the news, new analyst reports, earnings releases, and any other matter which may have an impact on the company, even when my only position is a senior bond.  So a position like DKR is kept very small even though the potential reward is large and the monitor is tight with mental stop losses.  Still, I know that some day I am going to be caught holding a worthless piece of paper and I just try to keep that day at bay for as long as I can. 

I have also mentioned that I frequently disagree with financial journalists. Maybe I rarely agree with anyone.  It would not be hard to find an article in Barron's for example touting Trust Preferred stocks.  I will buy them, but only when the yield makes it impossible to ignore them entirely.  They are issued mostly by banks after all. 

Bond investing is something that I would prefer someone else do for me. But that is not going to happen. I find it boring at times, more difficult than stock investing, but I am prospering over the last two years doing it myself and failed only when I entrusted a mutual fund to do some for me. This is certainly NOT  FOR THE VAST MAJORITY OF INDIVIDUAL INVESTORS DUE TO THE TIME AND KNOWLEDGE REQUIRED TO DO IT PROPERLY. I would suggest using bond ETFs which are very low cost these days and there are plenty available in every bond class that I can imagine.  I own many of them and have bought and sold others as I adjust my bond mix. 

I think that it is encouraging that Obama is considering business tax cuts in the stimulus package. It sounds like he is making an effort to reach out to the GOP.   

Many of the more nerdy types who read this post may want to read the 19 page letter that the SEC ignored from Harry Markopoulos detailing in 2005 the probable Madoff Ponzi scheme. November 2005 Report to SEC about Madoff Being A Ponzi Scheme - Fullscreen
It is also referenced in this blog from CBS news.
You have to learn to protect yourself and you certainly can not rely on a brokerage company or the SEC to look out for you. 

Sometimes, I can watch Cramer for as much as ten minutes. I have a lot of respect for his knowledge but he is too hyperactive for this acknowledge southern gentleman with very good manners.  I did note that he was pushing Hewlett-Packard (HPQ) today which is one of the major tech stocks on my monitor list.  I would more likely buy it than IBM but less likely to add it before Oracle which I do not currently own.   My process on these tech titans is admittedly very slow but, on the bright side, I did not ride them up or down in 1999 to 2002.  I am interested in them now, particularly the ones with a lots of cash on their balance sheets and solid businesses likely to survive and prosper over time notwithstanding the current dim outlook for a few months or even for the rest of 2009.

I had a comment the other day come into the email system at HG HQ saying that I was wordy enough to write War and Peace in a month. Yes, I would agree with the observation about the total number of words that I could crank out in 30 days, but that says nothing about the quality of the product. I do think and type fast for an old man.

I thought that I would post a picture of Honey Girl for a few days. I was impressed with Jack, the longhair but Honey Girl is better looking. 
  I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. In these posts, I am acting as an unpaid financial journalist and an occasional political commentator.   I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine.  Any discussion made by me of particular securities  is not a recommendation to buy or to sell.  Trade at your own risk.  Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons.  The sale may before or after the post.  Before buying or selling any stock, even one recommended by a trusted financial advisor,  please research it and make up your own mind which is what I always try to do.  Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news.  In this post, and all others by me, I am merely describing my reasons for purchasing  or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale.  The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile.  Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments.  Information contained in my posts has been obtained from sources believed to be reliable but cannot be guaranteed.  These posts by me do not constitute investment advice, nor shall they be construed as a guarantee of future results, or as an offer of any transaction in securities.   All content in these posts is provided for informational and entertainment purposes only, and it is a form of entertainment for me. 

No comments:

Post a Comment