# Chou Bond



## dustmaker (Apr 3, 2009)

Hi,

I am looking for advice. About a year ago I purchased Chou Bond Fund. My decision was based on his good reputation over the years and a very positive review from morningstar. Well, at some point it was down 38%, but somewhat recovered. Should I keep holding it? What is the future for high yield bonds?
thanks.


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## tojo (Apr 20, 2009)

dustmaker said:


> Hi,
> 
> I am looking for advice. About a year ago I purchased Chou Bond Fund. My decision was based on his good reputation over the years and a very positive review from morningstar. Well, at some point it was down 38%, but somewhat recovered. Should I keep holding it? What is the future for high yield bonds?
> thanks.


Dustmaker, 

looks like Chou Bond Fund is a very high beta, high yield bond fund. 3 year beta clocks in at 1.51 compared to 1.03 for its peers. During times of economic recovery, say decreasing spreads like now, this fund will probably do well but overall will experience high volatility.

If you have a high appetite for risk this may be suitable for you, but general practice is to hold bonds and bond funds to reduce overall volatility. 

The fund I hold personally is PH&N High Yield Bond. 3 year beta is only 0.53 and 5 year outperformance by a wide margin over the index and peers. You may want to look into this one for consideration. I've posted a comparison of the two funds from Globe Advisor for your review.

In general, high yield bonds have done extremely well year to date with narrowing corporate to government bond spreads. Outperformance will likely not be as high in the near future as things return back to somewhat normal. 

There are some more knowledgeable fixed income members on this board who can provide further insight and other suggestions . 



Statistics Chou Bond

As of July 24, 2009
Current Price: $7.96
Daily Change $: 
1 day: n/a
7 day: -1.25%
Month-to-Date: -3.89%
30 day: n/a
Year-to-Date: 25.50%
Returns as of June 30, 2009
Fund Group Avg Index*
1 month 8.10% 2.98% 2.98%
3 month 30.55% 11.54% 11.82%
6 month 30.58% 13.85% 14.18%
1 year -19.92% -3.07% -3.19%
3 year -4.08% 0.22% 0.39%
5 year n/a 1.29% 1.60%
10 year n/a 3.21% 3.03%
15 year n/a 5.77% 4.38%
20 year n/a n/a n/a
Since Inception 0.10% n/a n/a
3 year risk 19.52 10.05 8.48
3 year beta 1.51 1.03 1.00

Statistics PH&N High Yield Bond 

As of July 24, 2009
Current Price: $11.10
Daily Change $: $0.02
1 day: 0.17%
7 day: 0.38%
Month-to-Date: 0.79%
30 day: 1.18%
Year-to-Date: 10.39%
Returns as of June 30, 2009
Fund Group Avg Index*
1 month 3.46% 2.98% 2.98%
3 month 10.53% 11.54% 11.82%
6 month 9.52% 13.85% 14.18%
1 year 8.98% -3.07% -3.19%
3 year 6.76% 0.22% 0.39%
5 year 6.74% 1.29% 1.60%
10 year n/a 3.21% 3.03%
15 year n/a 5.77% 4.38%
20 year n/a n/a n/a
Since Inception 8.14% n/a n/a
3 year risk 5.75 10.05 8.48
3 year beta 0.53 1.03 1.00


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## mogul777 (Jun 2, 2009)

dustmaker said:


> Hi,
> 
> I am looking for advice. About a year ago I purchased Chou Bond Fund. My decision was based on his good reputation over the years and a very positive review from morningstar. Well, at some point it was down 38%, but somewhat recovered. Should I keep holding it? What is the future for high yield bonds?
> thanks.


As noted above with the strong recovery over the past 7 months it may be time to look at a lower risk option. That said the "recovery" is still going at this point. 

PH&N would be the recommended conservative choice. I've gone middle of the road with AGF Global High Yield Bond... don't care for the high fee, but a good fund. I have some leftover DSC keeping me with AGF to make the choice easy though.


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## Spidey (May 11, 2009)

I question whether it is the right time to be in high yield bond funds. If we end up with the inflation and higher interest rates that many are predicting, these things will really get whacked. As for mutual funds in general, I think the MER is often too high for most bond funds.

Lately, I've been putting my fixed income money into the Ishares short term bond fund. I cashed out all my PHN high yield bond fund a while ago. However, I do have some fixed-income dollars in the PHN bond and the TD CDN bond index-e. Aside from the Ishares short term bond fund, I'll probably consider the Ishares real return bond for future fixed income despite the pathetic yield.


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## Robillard (Apr 11, 2009)

Tojo,

Beta typically represents an investment's sensitivity to the market risk premium (or some proxy for it). Bond returns are not normally very highly correlated with the MRP, so beta is not usually a good measure of the systematic risk of a bond or bond fund. It may be better to look at duration data for a given bond (or average duration for a bond fund) since that gives you an estimate of the bond or fund's sensitivity to changes in interest rates.

dustmaker,
I don't know what will happen with high yield bonds, but not surprisingly, the last three to six months have been good for the fund as investors have rediscovered some of their appetite for risk. That being said, if you look at the top holdings (incidentally, Globefund, Morningstar and the fund's website all show slightly different holdings information), ask yourself if you would invest in the debt of those companies now. If the answer is no, then maybe you shouldn't hold on to the fund. A quick peek at the March 31 holdings of the fund (assuming that the information is reliable) shows that a few of the companies of whom the fund holds bonds are currently in bankruptcy proceedings. In particular, Abitibi-Consolidated, Primus Telecommunications, and Nortel are all in bankruptcy protection. In bankruptcy, only part of the value of these investments may be recoverable, depending on the seniority of the debts. Some of the other companies, whose debts are held by the fund, have weak cash flow such as CanWest and Expressjet. It might be some time before you make it back to breaking even on your investment. If you don't think this fund will perform well in future (relatively speaking), then you should consider redeploying your capital elsewhere.


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## OntFA (May 19, 2009)

Robillard said:


> Tojo,
> 
> Beta typically represents an investment's sensitivity to the market risk premium (or some proxy for it).


To clarify, a market risk premium is the amount of return -in excess of gov't treasury bills - that has either been experienced or that you are expecting from a given market segment. "Market" usually refers to the stock market but it can also denote the corporate or high yield bond market. Beta does not tell you anything about risk premium specifically. Beta uses historical returns to estimate the amount of exposure to a particular market (i.e. whatever market used to calculate the beta).



Robillard said:


> Bond returns are not normally very highly correlated with the MRP, so beta is not usually a good measure of the systematic risk of a bond or bond fund.


Beta is only meaningful if computed with a benchmark that makes sense. As Robillard mentions above, if Chou Bond's beta is calculated using the TSX Composite the beta will tell you nothing important. But if Chou Bond's beta is calculated using a relevant high yield bond index, then beta will be a valid piece of information. If you look at globefund, Chou Bond is compared against the group of high yield bond mutual funds tracked by globefund. This is a poor choice for a benchmark so don't pay much attention to it since Chou Bond is unlike most other funds in its peer group.



Robillard said:


> It may be better to look at duration data for a given bond (or average duration for a bond fund) since that gives you an estimate of the bond or fund's sensitivity to changes in interest rates.


This can be helpful, but few corporate bond funds provide this information. Also, because virtually all corporate bonds contain options that allow the issuer to buy back the bond under certain conditions, the posted duration and yield figures can be misleading.



Robillard said:


> ...ask yourself if you would invest in the debt of those companies now. If the answer is no, then maybe you shouldn't hold on to the fund. A quick peek at the March 31 holdings of the fund (assuming that the information is reliable) shows that a few of the companies of whom the fund holds bonds are currently in bankruptcy proceedings. In particular, Abitibi-Consolidated, Primus Telecommunications, and Nortel are all in bankruptcy protection. In bankruptcy, only part of the value of these investments may be recoverable, depending on the seniority of the debts. Some of the other companies, whose debts are held by the fund, have weak cash flow such as CanWest and Expressjet. It might be some time before you make it back to breaking even on your investment. If you don't think this fund will perform well in future (relatively speaking), then you should consider redeploying your capital elsewhere.


All valid points but the key as to whether this is a good investment is the purchase price. Chou (and other distressed debt experts) are buying oustanding loans of very troubled companies, by definition. So, Chou buys when fear of bankruptcy pushes the price so low that he's buying at a discount that gives him a good chance of a liquidation paying back his purchase price. Any interest on top of that is icing. And that icing can be a thick layer compared to the purchase price - which is the attraction of this asset class. It's not for the faint of heart and it requires patience but it can pay off. Just don't count this as part of your exposure to other government bonds.


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## mogul777 (Jun 2, 2009)

The benchmark index Globefund uses for Chou Bond is "Globe High Yield Fixed Income Peer Index". All funds are compared as well to their own category, which in this case is high yield fixed income and therefore virtually redundant. As noted it is necessary to look closer at the funds as obviously a PH&N does not compare well to Chou considering the relatively speaking astronomical risk of the latter fund. Anyway you slice it the Chou fund is comparative garbage as one would be better off with a pure equity fund when dealing with high risk investments.


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## tojo (Apr 20, 2009)

OntFA said:


> Chou buys when fear of bankruptcy pushes the price so low that he's buying at a discount that gives him a good chance of a liquidation paying back his purchase price. Any interest on top of that is icing. And that icing can be a thick layer compared to the purchase price - which is the attraction of this asset class. It's not for the faint of heart and it requires patience but it can pay off. Just don't count this as part of your exposure to other government bonds.


The strategy appears more like gambling then investing. It should be in a class of its own, rather than high yield bond - more like high risk bond. Sure it has a 3 month return of 30%, but so has many other more conventional investing plays. I'm struggling to picture what type of investor profile this is suited for - and I agree that you are just kidding yourself if you include this in the fixed income portion of your asset allocation...


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## Robillard (Apr 11, 2009)

Tojo,
Certain hedge funds, a few mutual funds (Chou Bond Fund included) and some private equity funds are big players in the market for distressed debt. One reason why distressed and high yield bonds have performed so well this year is that these bottom feeders (pardon the symbolism) are back on the prowl. Last fall when the market was going haywire, their investors were redeeming funds at a rapid rate, forcing them to sell these illiquid investments and driving up yields. Now these funds are back in the game and yields have come down a lot (pushing the prices of high yield bonds back up). Of course, some of those high yields were justified, as the bankruptcy filings I enumerated earlier attest.

There are essentially three possible outcomes for an investor in distressed debt:
A) The issuer enters bankruptcy liquidation and the investor loses most or all of their investment;
B) The issuer files for bankruptcy protection, restructures its operations and debts, and the investor recovers some or all of their investment (possibly as new equity issued by the company or bonds with an extended term to maturity); or
C) The issuer doesn't file for bankruptcy protection and returns to a modicum of financial health, causing the investor to make a killing as the bond price rises.
Of course, while waiting for any of the 3 main outcomes, the investor intends to collect interest with a fat yield, as OntFA alluded. 

So you are right, it is a lot like gambling. Distressed debt is not for the faint of heart or for small investors. In the event of the issuer entering bankruptcy protection, the bondholders often negotiate with the issuer to try to recover as much of their investment as possible. That is when the lawyers get involved. Small investors can find their claims practically ignored by a bankrupt issuer, which will try restructure their debts in such a way as to win over the largest and most senior bondholders (the ones with the highest priority claims).


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