Marilyn Cohen: Fallen Angels

10/31/2003 12:00 am EST


Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

They just don't get any smarter than Marilyn Cohen who has the remarkable ability to put the highly complex world of bonds into a clear and understandable format. Marilyn is president of Envision Capital, author of The Bond Bible, and columnist for Forbes magazine. Here are comments from her workshop and latest column.

"The whole idea of bond investing is safety, security, and diversification. In my 25 years in this business, I’ve learned to accept that you don’t know what you don’t know and that you’ve got to expect the unexpected. Who would have thought that bonds of Union Carbide in one day would go down 20 points–$200 for every $1,000 face value? Who would have thought that in one day, Enron would go from investment grade to bankruptcy? And while I don’t think that fraudulent era is still with us, the importance of diversification must be embossed in your memory.

"My mantra remains, that the best of the bond market is behind. I don’t think that we’re in a protracted bear market, but I think we will see some compressed spikes in yields that will scare the heck out of everybody. I think the Treasury market is very overvalued, and if perchance the dollar really crashes and burns, the hundreds of billions of dollars that foreigners own of our debt may be up for liquidation–so you could see a real debacle in the Treasury market. I'd add that there is no market that is more liquid and safer than the US bond market. And we’ve lived with this threat for years. But if such it did occur, it would be a really good buying opportunity.

"If you are managing a portfolio where you want safety and security, look for the strong credit profiles–companies with low leverage, solid assets. The best strategy now is to be very cautious and buy high quality bonds. A good bond investor is a patient investor, and you can add to positions each time interest rates tick up. The bull market is behind us, so you have plenty of time. On the other hand, you can 'tweak up’ a portfolio with some fallen angels." Here are some of her top picks in the high yield area:

"Some fallen angels are destined to be resurrected. With interest rates at less than tantalizing yields, it's time to sort through the discredited names and establish some very selective holdings. But don't let your hunger for yield make you overlook important fundamentals. (Two kinds of issuers to avoid: asbestos-linked businesses and investigation targets.) The numbers suggest that some fallen angels now stand a better chance of recovery. Not only will better economic times help them, but also their average debt burden is lighter than that of comparably discredited borrowers in the past.

"With junk defaults easing, odds are that the angels' prices have seen their low points. The ones I like, in fact, are selling at a premium–and are worth every penny. Their coupons are high enough that they comfortably outyield comparable Treasurys and investment-grade corporates. While you should be skeptical about a lot of junk bonds out there, the bonds most likely to add value to your portfolio are from companies that have made strides in strengthening their balance sheets and cutting costs. To reduce the risk, stick to short- and medium-term maturities.

"Among the names I like is Avnet, a semiconductor and computer products distributor. The tech downturn over the past several years has killed its profits and thus its interest coverage–a key measure of debt-servicing ability defined as the ratio of earnings before interest and taxes to interest expense. With a little luck and a tech-spending rebound, Avnet will be in fine shape to repay its lenders. The Avnet 7.875s due Feb. 15, 2005 are trading near 103 to yield 5.5% to maturity, which is 3.5 percentage points more than the two-year Treasury note.

"Another good choice is the Bausch & Lomb 6.95s due Nov. 15, 2007, priced at 106.25 for a 5.2% yield to maturity. One year ago Bausch & Lomb had liquidity and balance-sheet problems. During the summer the company successfully managed to restructure its debt and greatly improve its cash flow.

"Starwood Hotels owns, manages, and franchises hotels worldwide, mostly under the Westin and Sheraton brands. Management has sold assets to reduce debt, improving the balance sheet markedly; with a weensy recovery in lodging demand, this company is poised to recover. The Starwood 7.875s due May 1, 2012 trade around 109.50 for a 6.4% yield to maturity.

"So buy a few fallen angels. As always, if you buy any junk bonds to juice up your portfolio, buy more than one; diversification is vital in this risky kind of investing. These picks may not go back to investment grade anytime soon, but they pay well enough that it doesn't matter."

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