Bonds Are Buys

11/25/2008 1:00 pm EST

Focus: BONDS

Tim Middleton, contributor to MSN Money, says investment-grade corporate bonds look attractive now, and he recommends three funds that own them.

For months, investors have been debating whether we are entering a period like the 1930s: hard times and high risks, but big rewards down the road for those who can take advantage.

In the world of corporate bonds, we are already there. This slice of the bond market is priced low, as if dozens of companies won't be able to make good on their debts, presumably because they'll go broke.

But you can find these low prices even on the gilt-edged bonds of rock-solid corporations such as General Electric (NYSE: GE), Berkshire Hathaway (NYSE: BRK.A) and Johnson & Johnson (NYSE: JNJ).

"The corporate marketplace is pricing in default rates several percentage points higher than we've seen in our lifetime or even the lifetime of the bond market," says Elaine Stokes, a co-manager of Loomis Sayles Bond Fund (LSBRX). "This is absolutely a buying opportunity."

Bonds look more attractive [than stocks,] because they're much, much more secure. One big reason: If a company does go broke, bondholders get paid before stockholders. And the truth is that even in this lagging economy, major US companies are not about to go bankrupt en masse.

In Europe, the debt-to-equity ratio averages 75%; in Japan, it's more than 90%. In the US, it's only 40%. "The aggregate corporate balance sheet is in pretty decent shape" in this country, says Brian McMahon, chief investment officer of Thornburg Investment Management.

Right now, you can buy more yield for less money. So investors stand to reap capital gains as well as dividends when prices head back up.

Corporate bonds account for roughly one-third the weighting of the Lehman US Aggregate Bond Index, and pulled it down more than 3% in October, its worst month since February of 1980, when interest rates were topping 16%. So any intermediate-term bond fund—the largest is Pimco Total Return (PTTRX)—is a buy in today's market.

But specialized vehicles that invest strictly in corporates, such as the iShares ETF, are likely to provide the most bang for the buck. Multisector bond funds, such as Loomis Sayles Bond and T. Rowe Price Spectrum Income (RPSIX), are also good candidates.

Aggressive investors tend to avoid bonds altogether, because bonds are often viewed as safe but underperforming. But this is a different investing world.

The bottom line is that this asset class is perhaps the most compelling investment opportunity in today's market place. I expect equity-like returns, well into double digits, over the next year or two.

Best case, I can see high-quality corporate bonds surging 15% on price alone as their premium over Treasurys falls back toward the historic norm, with dividends chipping in 6% to 9% over the next 12 to 18 months. Few stocks can deliver returns like that, especially in this market.

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