Lehmann's Best Bond Buys

11/08/2002 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann has been a bond market expert for two decades and his newsletter is the only independent publication dedicated to providing investment advice on bonds, preferreds and convertibles. His advice is not just meant for retirees. He says, "We believe fixed income securities have a place in all investment portfolios no matter the age, wealth, or risk tolerance of the investor." Here's his outlook for the bond market and some top picks for both high income and potential capital gains.

“We’ve had a good run for three years. The outlook for next year? Most commentary calls for interest rates to go up. But I hesitate to say that, because quite frankly, that was the outlook at the beginning of this year, when the expectation was that stocks were going to go up therefore interest rates were going to rise. That didn’t happen. In fact, we are down a hundred basis points since the beginning of the year. 

“While the outlook is a little more positive for the stock market, we note that there isn’t necessarily a direct connect between interest rates and the stock market. For example, in the current situation, investment grade rates have gone down 100 basis points, but the high yield sector of the bond market has seen yields go up substantially. This is due to what is called the flight to quality, and this is taking place here in anticipation of an Iraqi war. This happened during the Gulf war as well. This phenomena occurs when investors are looking for safety in case something goes wrong. Three months after the Gulf war, rates had come back down to normal levels. 

“We encourage investors to make their own selections among bonds. Bond funds have management fees that tends to be a burden. The main exception is regarding high yield bonds. Within the high yield market, a fund is a good idea, because it requires quite a bit of skill in selection. However, we would caution people not to get into a high yield bond fund until January 1st, because if you get in now – before year end – you are going to inherit the tax consequences that the fund built up over the entire year. Whoever is holding at year end gets the gains or losses that have accumulated in the fund, so we'd suggest waiting.

“I have two specific recommendations that are at opposite ends of the spectrum. Both are convertible preferreds. The first one is Ford Motor Co. convertible (F NYSE). Last year, the company issued a $5 billion convertible issue at $50 a share. Since then, Ford common stock has taken a beating. These converts have dropped as well. Today, the Ford convertibles are yielding almost 9%. Ford common is now near $9. When the stock gets back to $13, these converts will trade dollar for dollar upward with the common. Investors have 30 years on these convertibles. And you will be collecting 9% on a quality company and a play on the stock above $13. I don’t think too many opportunities like that come along every day. That’s what I would call a safe type of play.

“Because of Enron, many other companies in the energy field have been terribly beaten up this year. We like the Mirant convertible preferred (MIR-A NYSE), which is backed by a bond. Mirant is mainly a power generating company, but it also happened to trade energy and thus suffered from the Enron effect. It’s beaten down to the point where at current levels, it’s yielding 35%. That's a phenomenal potential return. It’s a preferred issue trading at around the $9 level. It’s a $50 par value stock. In theory, if they never convert, in 30 years it will be worth $50. 

“The company’s cash needs are basically for the completion of plants currently under construction. This is a controllable expense. So far, they have been selling off existing plants to provide the cash to finance the completion of newer ones. The market is gun shy about this stock, due to pending lawsuits in California. Because Mirant has been named along with a number of other companies, the market takes the viewpoint that California is going to bankrupt the firm. I don’t think that is going to happen and consequently, the opportunity is here to get a very high return and a tremendous potential capital gain.”

Editor's Note:  All excerpts from the Forbes editors in this issue of The Money Show Digest are from a panel discussion held at the New York Money Show on Friday, October 25th.  Quoted stock performance, portfolio performance, etc., have not been updated to reflect changes in the market since that date.  

For information on the Forbes group of newsletters, visit www.forbes.com/newsletters.

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