BBB Means Buy, Buy, Buy
It's early for cautious income investors to rush into high-yield bonds, though junk's completing one of its best months in a long time. But the nearest category to junk -- the lowest tier of investment-grade corporate bonds, meaning those rated BBB by Standard & Poor's or Baa by Moody's -- is a comfortable alternative.
Moody's reports that Baa-rated corporate bonds finished the week ending April 25 yielding an average of 7.0%, with industrials at 7.15% and utilities at 6.85%. That's peanuts compared with the 11% you can get from my favorite oil royalty trust, BP Prudhoe Bay (symbol BPT).
But crude oil, which powers the trust's dividends, may be in bubble-land. If the price of oil corrects, BPT, which closed at $95.69 on April 28, could head for the $70s. If you own the stock, I encourage you to enter a stop-loss order for about $90 and to do it quickly.
Investment-grade corporate bonds, on the other hand, should cause no such concern. One reason yields are up is that companies are issuing bonds like mad, either out of necessity to bolster balance sheets or because they are scouting for acquisitions and can't count on banks for the capital.
A surfeit of supply puts pressure on yields to go higher. And some foundations, trusts and endowments are unable to own bonds rated BBB and lower, says Bill Larkin, who manages income portfolios for Cabot Money Management, in Salem, Mass. That means that demand for bonds in the BBB range is tempered.
Adding to the luster of BBB debt is the puny payout on Treasury bonds. The spread between corporate and government bonds is unusually wide because the credit panic sent a tsunami of money into the assumed safety of Treasuries, not because a mild recession threatens the solvency of low-investment-grade issuers such as Heinz and Time Warner.
A ten-year Treasury bond that pays 3.9% is a guaranteed loser after current inflation and, if applicable, taxes. But if you earn 7%, you can still make a profit after taxes and inflation. And there are enough choices in BBB territory to be able to assemble a package that is diversified by both issuer and maturity.
I searched the Charles Schwab bond database to see what's available. The bond search engine lets you specify whether to include callable or non-callable bonds and to choose maturities along a range of up to 30 years.
I selected non-callable bonds with maturities between 15 and 30 years and was pleased with what I saw. One bond that screamed, "Buy me" was from the giant Brazilian minerals company Vale, which is really a global concern and, as the Wall Street Journal recently observed, has a better credit rating than the government of Brazil.
The Vale bond has a coupon rate of 8.25%, is due in 2034, and pays interest in January and July. On April 25 it was priced at a current yield of 7.2% and a yield to maturity of 7.0%. But Moody's is reviewing Vale for a possible upgrade from Baa3. If Moody's did raise its rating, the bond's principal value would probably tick up a bit.
If you'd feel better with a shorter maturity, look at bonds from AT&T Broadband and Time Warner. Both have bonds maturing in 15 years and rated Baa2. AT&T's is priced to yield 6.8% to maturity and Time Warner's is priced to yield 7.2%. Ma Bell pays in May and November, while Time Warner pays in February and August. Time is under review for a possible downgrade, which explains the higher yield.
Schwab's list of issuers rated BBB or Baa includes Burlington Northern, Conagra, Corning, Eastman Chemical, Lockheed Martin, Nordstrom, Tenneco and Weyerhaeuser. If you do business with Fidelity or any other good broker, you can easily find plenty of good ideas.
No company is bulletproof, so you want to diversify. With these names, you can assemble a portfolio that includes companies in such widely disparate industries as transportation, food, defense, chemicals and construction. I know you can get a yield of close to 6% from Vanguard Long-Term Investment-Grade (VWESX). But if ever there was a good time to buy your own bonds and pocket a really good yield, this is it.