We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...
Making Money Off So-Called 'Junk'
03/28/2013 9:00 am EST
Don't be afraid of high-yield bonds, says Marilyn Cohen of Envision Capital Management, because the market is miles better than it was in Milken's day...and right now, the income opportunities are impressive.
Nancy Zambell: My guest today is Marilyn Cohen, the founder of Envision Capital Management out in Los Angeles. Welcome Marilyn, and thanks for joining me.
Marilyn Cohen: My pleasure.
Nancy Zambell: What's going on with the bond market today?
We've heard all of these people talking about it, saying how it's going to get
better, and nothing's happening.
Marilyn Cohen: Nancy, I've been in the bond business for 34 years, and I've never heard such anxiety—such mashing of the teeth and ringing of the hands—regarding bonds.
People are really worried about bond prices going down and yields going up. They're worried about inflation. They're worried about this huge balance sheet the Fed has created for itself, and how the Fed is going to extract itself.
And it's not just the little do-it-yourselfer that's worried. You hear all the talk on CNBC and Bloomberg, articulating the same thing. And in the meanwhile, nothing's happened.
I think the bet is that the Fed is going to continue doing what they've been doing. Bernanke has been very clear about that.
I think if there's any takeaway from our conversation today, it's watch the Fed and listen to Bernanke. Because no matter what the Federal Reserve Regional presidents say on CNBC or put in the Wall Street Journal in an op-ed, when they are behind closed doors, they all seem to vote in favor of what Bernanke wants.
There was only one Fed dissenter recently. It's business as usual. The Fed is going to continue its $85 billion monthly purchase of securities until we hit a closer to a 6.5% unemployment rate and/or inflation goes above 2%.
Now a lot of people say, "Oh, but that 2% is a bogus number." I get that, but nevertheless, it's the Fed's number. And when you take a look at how this game is rigged-in which the Fed is not only the referee, but the single player on the field-it's their game. You may not like the game, but it's the game that the markets are going by.
Nancy Zambell: What's the old adage..."Don't fight the Fed," right?
Marilyn Cohen: Exactly—and that old adage is true. Anybody who sat on the sidelines because they were afraid about interest rates going up has missed an unbelievable last four to five years, even if it's the end of a bull market.
Nancy Zambell: What do you think is going to happen for the rest of the year—just more of the same?
Marilyn Cohen: I do! I really do. It's been very clear that is what the Fed is going to continue to do. It's a buying program.
And unless we see the economy really get rip-snortin' hot, or inflation-for some odd reason-really break out of its lethargy, I think that the Fed is going to have exactly the same mantra for the rest of 2013. They don't want any false starts and full stops. I think that they feel that they have a lot of wiggle room.
So go by what the market is telling you. The ten-year yield is a little under 2% one day, perhaps a hair over 2% the next day...but that ten-year is really your litmus test to verify or negate what the Fed is doing.
Nancy Zambell: Investors, of course, have flown into the equity markets in the last few months, making them reach highs that were never seen before. So does that mean that most investors they should just ignore bonds? Or, is there always room for bonds or a bond fund in someone's portfolio?
Marilyn Cohen: I think there's always room, because once the stock market sells off, you're going to want that rudder to be locked and loaded, and be able to right-size a capsized portfolio.
Everybody has been screaming about how the great rotation is going to have bond money go out of the bond funds and bond market into stocks, but that isn't what's happened. Just as you've said, we've reached new highs in equity, but it's been money off the sidelines. That has helped propel the equity market. You can't believe what these gurus are telling you, because you have to look at the facts.
I don't think you do business as usual in bond land. I don't think that you buy long-term bond funds, or 30-year individual bonds. You shorten it up and you shorten it up a lot, to the intermediate to short-term sector. Sure, you'll give up a little bit of yield-but that's all, Nancy. It's just a little bit of yield. It's not 100 basis points of yield.|pagebreak|
Nancy Zambell: A few years ago, a lot of people in the bond area were suggesting that people ladder their bonds—do some short-term to intermediate, some long-term. Are there still investors that think that is a good strategy?
Marilyn Cohen: I think it's a good conceptual strategy, but I think you have to shorten up the ladder. And maybe you budge some of your maturities to three to seven years.
Many bonds have yet to be called-even high-coupon bonds. I think that a lot of people should buy yield-to-call bonds-bonds that have a high coupon that the company has not yet called in-because maybe they'll call them in 2015 or 2016. That yield is significantly higher than if you buy a non-callable bullet bond. I think that kind of strategy works.
And I think that people have to lower their expectations as far as credit quality, because the majority of bond land is now in the Bs. And you can't be afraid of the Bs-the BBB+, the BBB-so you're going to have to lower your expectations as far as credit quality. It doesn't mean they're bad; that just means that there aren't that many A, AA, and AAAs out there anymore.
There's a way to navigate around all of the angst in bond land, and you just do it smartly, by not buying long-term, shortening your duration, and sticking with a lot of callable paper that if you have to replace it, so what?
Nancy Zambell: A lot of investors can't afford to go out and buy individual bonds. So are you an advocate of bond funds?
Marilyn Cohen: There are some bond funds that I think can do a better job than most individual investors can do themselves.
The high-yield market continues to be extremely, extremely well-bid for, even though a lot of people say it's overvalued. I agree with it-it is overvalued. Spreads are tight, nominal yields are low.
But one exchange traded bond fund that I really like is Peritus High Yield Exchange Traded Fund (HYLD). It's an actively managed ETF, unlike most of them that are just based on certain indexes. You've got managers that when things go right, they'll add on. When things go wrong, they will get out.
A lot of these positions in the Peritus High Yield Fund are 144A, which means they are not FCC-registered, which means people couldn't buy them on their own. It's yielding a little bit over 7.5%, buying junk bonds. Some are junk to be junk, some are junkity-junk with a story, but I think that the stories are extremely compelling.
Nancy Zambell: That's a very nice yield.
Marilyn Cohen: It certainly is. The expense ratio is high, too. It's 1.35%.
I have interviewed the head portfolio managers, and these are people that are very, very, astute investors. They don't take huge positions in any one bond. Usually it's less than 3%. So if something happens, I always tell people it's like a paper cut; it's not like a bleed out.
But I think that there's value there. It's not following any index like JNK or the various other high-yield exchange traded funds.
Nancy Zambell: Now, in terms of individual bonds...what would you recommend?
Marilyn Cohen: I would recommend things that other people aren't looking at. One company that I really like that I have followed and owned off and on for clients year-in and year-out is Iron Mountain Services (IRM).
In its old days, Iron Mountain was just a storage facility, in which whether you're a doctor, lawyer, or Indian chief, you have to take your client files and store them someplace eventually, because your office can't hold them.
They've also entered the technology end, doing backups for computers and storage systems offsite. So when you have a meltdown with your computer system, they are one of the companies that restores them very quickly.
Iron Mountain has some 7.75% bonds (CUSIP: 46284PAN4) that are due in October 2019, but callable in 2015, so if Iron Mountain continues to call their paper like they have been, that's about a 4.2% yield to that 2015 call. If they go all the way to 2019, it's a 5.6% yield. I think there's value there. It's B+ rated.
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