Driving for Income

05/27/2005 12:00 am EST

Focus:

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Here, Richard Lehmann, an expert in fixed income, offers an exceptional overview of auto bonds. Given the complexity of this area, I caution that acting on this advice should be done only with a full understanding of preferred bonds, or with the guidance of your professional advisor.

"The last three years, the concern has been when are interest rates going to go up? And in each of those years, interest rates came down. And we are still sitting here with the same question.  I don’t think that rates will go down much more, but I also don’t see anything that will be pushing them up either. I think the concern about rates is more an historical concern than one based on actual events on the horizon. Granted the bond market is probably one of the most overpriced markets there is, but that’s due to the fact that there is somewhat of a shortage of supply of quality bonds. 

"T his doesn’t mean that you need to sit there and take a chance with interest rates. There are ways to balance your portfolio holdings in the fixed income area to protect yourself against an eventual rate rise, such as buying convertible securities, Canadian oil trusts, etc. We also like the preferred market, which is actually bonds in $25 denominations that trade on major exchanges and are much better vehicles for individual investors. I would suggest that investors look at opportunities in these preferred issues related to General Motors and Ford.

"As background, consider between them, GM and Ford have about $400 billion in debt. When they suddenly get downgraded to junk, we see a capacity problem, as the entire $900 billion junk market has to suddenly absorb an additional $400 billion in supply. In my view, GM and Ford paper is underpriced because there aren’t enough buyers. This fuels media sentiment that they must be going bankrupt. But it is just a disjoint between buyers and sellers that will eventually iron itself out. It will take a few months. But for individual investors this is a great opportunity to buy names like GM or Ford at 9% or 10% yields.

"There are a multitude of choicesover a dozen issues of both General Motors and Ford. They are referred to as preferred stocks, but they are actually bonds. They are denominated at $25 par value. Most are trading at around 19, and currently yielding 9% to 10%. I think when this market correction is finished, they’ll be back up around 23 and the will be yielding closer to 8% or less. In terms of specific tickers, (RGM NYSE) and (XGM NYSE) and (BGM NYSE) are three typical ones. For Ford, they are what are called trust preferreds, in that they are bonds that were put into a trust before the shares were issued. These were created by brokerage houses, while the GM preferreds were created by GM themselves. For Ford, the ticker symbols (KSK NYSE) or (PIJ  NYSE) are two examples. But there are about a dozen to consider."

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