# Bond selection criteria



## SixesAndSevens (Dec 4, 2009)

i'm planning to buy and hold bonds in my retirement account.
when I screen bonds, what are the conditions for evaluation?
so far, I have been looking at YTM, company profile and the DBRS rating.
Regarding the rating, if I want to be conservative, should i stick to grade A and above only?
anoher question: is anyting trading below par automatically risky/junk, regardless of rating and company profile?
should i even look for anyting trading below par or is that asking for trouble?


----------



## leslie (May 25, 2009)

A bond trading below par indicates that the market wants a higher return than the return they wanted when the bond was issued. This may be because of some company specific issues, or it might be the general business cycle has changed, or it might be that inflation expectations have changed.

Last year the availability of cash for companies died up completely as investors wanted the safety of government debts. Corporate debt became more risky for almost ALL companies. More perceived risk >> higher yields demanded >>lower bond prices = discounts to par.

Yes some companies were reclassified as junk in the process, but a lot of basically great companies had the same thing happen to their debt. During the 2003-2007 bull run, investors were UNDERVALUING risk, so all debt issued during that period had very low coupons. Now things are more like long-term historical rates - higher.

An important issue you are missing is duration. My calculator gives me the metric, and I think there are some web calculators, but I don't know any addresses. Here is basic bond calculator created by Hank Cunningham.

How much risk you are willing to accept, and the returns you need to compensate is your personal decision. No one can tell you.


----------



## SixesAndSevens (Dec 4, 2009)

Thanks leslie.
I am aware of the concept of duration and its corelation to interest rates.
Which is why I am considering only short term bonds (< 5 years).
My risk profile for this investment is very low since it's a retirement account.
I noted that there are many below par bonds issued by provincial and municipals at zero coupon rates.
What is the explanation for issuing zero coupon bonds by such institutions - surely provincial and municipal govt. can afford to pay interest rates.

one more question: is there a prospectus issues for every bond just like there's one for every shares issues?
can i take the CUSIPnumber and search SEADAR or any other site for a bond prospectus?


----------



## leslie (May 25, 2009)

Strip bonds (no coupons) need not have been issued that way. There probably are some - don't know - but... The bond industry participants themselves create the strips by buying the complete bond, and then breaking it up into separate parts that trade individually. 

So if the original bond issue had XXX of face value paying interest on (say) January each year = $50,000, then a single payment due Jan 2015 could become the 'principal' of a separate strip. And retail investors can buy just that one payment.

This is done because a lot of people like strips. They are very useful. Say you want to fund one separate year of retirement 20 years from now. You buy - at a big discount - the strip with the one payment in that year. Now you don't have to worry about 'reinvestment risk'

They are also great for periods when you think interest rates will be falling. Because their duration is at the extreme, their value will increase the fastest of all bonds (for a given maturity). I bought my first strips in early 1980's when exactly that was happening.
http://www.cds.ca/cdsclearinghome.nsf/Pages/-EN-Stripbondservices?Open
----------------------------
You are coming to the wrong conclusion re: buying short maturities to protect from duration effects. Implicit in your reasoning is: that a rise in interest rates (by the central bank on overnight rates) will also rise longer maturity bonds by the same amount. 

But it might well be that inflation stays low because of international forces that have not changed in the past 10 years. That the central banks have learned they have to raise rates to counter bubbles, even while inflation is low. In that scenario, while the short bonds will suffer from the rise of the T-bill rate, the longer duration bonds may be effected less because the yield curve flattens out.
http://www.bondsonline.com/Chart_Ce...2=bc_20year&date1=01/01/2006&date2=12/01/2009


----------



## SixesAndSevens (Dec 4, 2009)

leslie said:


> Strip bonds (no coupons) need not have been issued that way. There probably are some - don't know - but... The bond industry participants themselves create the strips by buying the complete bond, and then breaking it up into separate parts that trade individually.
> 
> So if the original bond issue had XXX of face value paying interest on (say) January each year = $50,000, then a single payment due Jan 2015 could become the 'principal' of a separate strip. And retail investors can buy just that one payment.
> 
> This is done because a lot of people like strips. They are very useful. Say you want to fund one separate year of retirement 20 years from now. You buy - at a big discount - the strip with the one payment in that year. Now you don't have to worry about 'reinvestment risk'


I see....so 0 coupon below par bonds are not inherently more risky than a similar term coupon bond issued by the same authority (provincial, federal, etc.), correct?

Do bonds have prospectus like stock issues (on SEDAR or anywhere else)?
i am looking for any other evaluation factors for a bond beyond the credit rating, YTM and the duration.
or maybe that is all that is there to evaluate in bonds?


----------



## scomac (Aug 22, 2009)

SixesAndSevens said:


> I see....so 0 coupon below par bonds are not inherently more risky than a similar term coupon bond issued by the same authority (provincial, federal, etc.), correct?


A zero coupon bond will have a longer duration than a bond of the same maturity that pays a coupon, therefore there is greater interest rate sensitivity with zeroes.



> Do bonds have prospectus like stock issues (on SEDAR or anywhere else)?
> i am looking for any other evaluation factors for a bond beyond the credit rating, YTM and the duration.
> or maybe that is all that is there to evaluate in bonds?


When a corporate bond is issued, there will be a corresponding prospectus for it. A single prospectus may cover more than one issue. Other things to look for and evaluate are call options, call premia, convertibility, rate adjustments, etc.


----------



## leslie (May 25, 2009)

But finding that prospectus has always been beyond my ability (the very few times I have tried to find one). Very few companies make it 'find-able' on their website. And unless you know when it was issued it is a royal pain to find on SEDAR. That code that you see on the broker's bond list is not a searchable identifier (that I know of).

If anyone has cracked this problem, please contribute.


----------



## scomac (Aug 22, 2009)

leslie said:


> If anyone has cracked this problem, please contribute.


Trial and error. The annual information circular contains some valuable bits of info (dates mostly) on outstanding issues that will help you search SEDAR for the actual prospectus. One way or another, I've managed to find the corresponding document for any of the issues that I own. I would concede though that my search hasn't always been fruitful for all issues that I was contemplating.


----------



## SixesAndSevens (Dec 4, 2009)

scomac said:


> A zero coupon bond will have a longer duration than a bond of the same maturity that pays a coupon, therefore there is greater interest rate sensitivity with zeroes.


if the credit rating and the YTM is acceptable to me, do i still need to worry about duration?
i understand there is opportunity cost if interest rates rise, but i don't intend to sell.


> When a corporate bond is issued, there will be a corresponding prospectus for it. A single prospectus may cover more than one issue. Other things to look for and evaluate are call options, call premia, convertibility, rate adjustments, etc.


Attached is a screen of a bond quote from my online brokerage.










other than the parameters displayed here, do i need to know anything else when researching bonds?
i have not been able to find any prospectus for this issue either at SEDAR or at the issuing company website using the CUSIP#.
what else should i investigate as part of my due-diligence when considering this bond?


----------



## scomac (Aug 22, 2009)

SixesAndSevens said:


> what else should i investigate as part of my due-diligence when considering this bond?


You have to know what the call provisions are because if you don't you
have no idea what your actual YTM might end up being. You have to know ahead of time what your worst case scenario is going to be otherwise you might just end up buying a bond that sells at a premium, is called early and results in you losing money on it. You don't deliberately buy a bond where you can lose on a early call. It happens a lot, but that's just because people don't do the necessary homework. Then you'll hear them say that they won't ever buy a corporate bond again because they lost money on them. The problem wasn't the bond as an investment, the problem was not doing the homework and as a result paying the price.

With respect to the bond that you have highlighted. If you can't find the documents you need on SEDAR or the company website, then call investor relations. If that draws a blank, then walk. There's a reason that bond is yielding 4.30% for 3 1/2 years and it's not because the issuer is generous.


----------



## leslie (May 25, 2009)

The printout says 'no cal' so that is not an issue (here). But really ... WHY would you want to buy this company's debt. You can get a 7% distribution from US pref shares ETFs that give you a diversified basket of these financial risks. 

Changes in interest rates, and duration is immaterial if you hold to maturity (unless the inflation built into your valuation turns out to be higher). BUT ..... your intentions can/will change. I also have told myself I would hold to maturity ... only to change my mind later. Stuff happens. I would never make a purchase based on that assumption now.


----------



## SixesAndSevens (Dec 4, 2009)

leslie said:


> The printout says 'no cal' so that is not an issue (here). But really ... WHY would you want to buy this company's debt. You can get a 7% distribution from US pref shares ETFs that give you a diversified basket of these financial risks.


Wow...what's the ticker symbol for this ETF? 
Is it Canadian or traded in the US?
And how are US Bonds able to provide that kind of yield - aren't US interest rates at almost 0%?


----------



## scomac (Aug 22, 2009)

SixesAndSevens said:


> And how are US Bonds able to provide that kind of yield - aren't US interest rates at almost 0%?


For starters, leslie isn't talking about bonds, he's talking about a basket of preferred shares -- there's a very significant difference. Preferred shares are subordinate to debt; most have no fixed maturity and a default cannot force bankruptcy. Even though preferred shares can be very bond like at times, it's still equity; it isn't debt.

With respect to US interest rates being near zero, that is the overnight rate set by the Federal Reserve or basically what the US gov't is willing to pay for short term borrowing. If you are a company that wants to borrow for a longer term, there are a whole host of risks that must be priced in to the cost of that capital with credit risk and term risk being the most immediate.


----------



## SixesAndSevens (Dec 4, 2009)

scomac said:


> For starters, leslie isn't talking about bonds, he's talking about a basket of preferred shares -- there's a very significant difference.


oh right, ****. I didn't read leslie's post carefully enough and didn't realize he's brought preferred shares into the discussion. i am ware of differences between preferred shares and bonds.
i would still like to know the ticker for the ETF leslie mentions.
i believe the Canadian CPD also pays distributions in the 5% to 6% range.
thanks for catching the pref. vs bonds gap that i missed.


----------



## leslie (May 25, 2009)

I brought pref shares into the discussion because of the choice of Citygroup for a bond. IMO I would not go near that company's debt without equity level returns expected - regardless of what some outfit says different. I should have noted that.

The US etf with pref shares have higher yields because so many of the US Financial companies are still in do-do - like Citygroup.

Pref shares info


----------



## SixesAndSevens (Dec 4, 2009)

leslie said:


> The US etf with pref shares have higher yields because so many of the US Financial companies are still in do-do - like Citygroup.


So why are you recommending the US ETF? just for the yield?
what's the ticker symbol of the US pref. ETF?

thanks


----------



## SixesAndSevens (Dec 4, 2009)

I have been screening for bonds on my online brokerage and not having much luck.
i searched for short term bonds with YTM at 5% or more and came up with a very small list (screen below)








This is pretty slim pickings. and look at some of the dubious names on that list - HBOS, YPG egh!

what am I doing wrong?

do i need to go medium term to get yields in the 5%+ range?
if so, what's the difference between bonds and GICs?
I can get a 5 year GIC for 3.25% with zero risk.
Why buy a BBB bond for 5.5% - 6% and take on all this risk?

what's wrong?


----------



## scomac (Aug 22, 2009)

[QUOTE="SixesandSevens" ]what am I doing wrong?[/QUOTE]

Nothing. That will be the extent of your broker's inventory in bonds that meet your selection criteria.



> do i need to go medium term to get yields in the 5%+ range?


Yup. You'll have to be willing to go out at least 10 years in order to get a decent credit rating from a domestic issuer.



> if so, what's the difference between bonds and GICs?


Liquidity, term length, credit risk and yield.



> I can get a 5 year GIC for 3.25% with zero risk.
> Why buy a BBB bond for 5.5% - 6% and take on all this risk?


You've answered your own question. All of those risks aren't worth the yield advantage to you.



> what's wrong?


Nothing. This is how the bond market prices various forms of risk. The problem is that retail investors don't realize the risk they assume with GICs because the price doesn't fluctuate on the open market, but you are assuming these risks none the less. 

Just compare your GIC rate to a GoC bond of the same term to find out exactly what you are being paid for a lack of liquidity. Wholesale, it's 70 basis points, so it's going to be over 1% at the retail level. Almost a third of the return on a 5 year GIC is to compensate you for a lack of liquidity; that's how big of a deal that is.


----------



## SixesAndSevens (Dec 4, 2009)

Thanks, scomac.
so I'm going to ask a stupid question now.
If this is the reality of bond investing and if I'm not doing anything particularly wrong in my searches, then why would anyone wanna invest in bonds?
I assume there are thousands of small-time, individual retail investors like you and I who are investing in bonds - why?
just for the sake of 1% extra return?
or does everyone go long and buy 10+ year bonds and hold to maturity?

or is this just a bad time to be looking at bonds?


----------



## John_Michaels (Dec 14, 2009)

SixesAndSevens - actually, I'm currently going through that struggle. I see PWF & SLF & T & EMA at dividends >4% and the after-tax compared to interest is even better...why would I buy bonds?

Obviously less risk (MFC dividends WERE looking good)

But... I've bought into the whole Dividends-investing mindset in the last year (was mutual funds). These high dividends and low bond interest differences are really unusual I think.

I'm going to try to take advantage of this before the market swings to 'normal'. I'm guessing 'normal' are dividends in the 2%-3% range and bonds in the 4%-5% range? 

I believe there were a number of articles a few weeks (months?) back along the same vein...can't find them now, sorry.


----------



## scomac (Aug 22, 2009)

> If this is the reality of bond investing and if I'm not doing anything particularly wrong in my searches, then why would anyone wanna invest in bonds?


There is a bit of a problem with your bond searches. Your expectations in terms of yield in relation to term aren't particularly realistic in the current environment. For the sort of yield you are requiring, you are going to have to take on a fair bit of credit risk. You might pick up a half a percent or so of additional yield with a good quality corporate bond over and above a GIC right now for a similar term, but not 2% plus. 



> I assume there are thousands of small-time, individual retail investors like you and I who are investing in bonds - why?


Stability, income, certainty of return and a measure of safety. With a bond ladder that you intend to hold to maturity, you know what your return will be when you buy. With equities there is no such certainty, there's no way to defease a future liability with any degree of certainty.



> just for the sake of 1% extra return?


That's more than enough to make it worthwhile if you aren't assuming disproportionately greater risk.



> does everyone go long and buy 10+ year bonds and hold to maturity?


For retail investors it is very desirable to hold to maturity due to the costs associated with trading. The bond ladder is the best way to go holding a series of bonds from one year maturity to 5 year or all the way out to 10 year if that's your preference. The only downside with ladders is that it requires a substantial capital base to be worthwhile.



> is this just a bad time to be looking at bonds?


That seems to be the consensus because interest rates are low. I'm not of that opinion due to the low inflation environment and the steepness of the yield curve. The cost to stay short right now is very high.


----------



## SixesAndSevens (Dec 4, 2009)

scomac said:


> The cost to stay short right now is very high.


can you pl. explain this a bit?
what do you mean by cost to stay short?
the longer you go, the more interest rate and credit risk you take on.
how can you go wrong by going short term?

btw, the Consumer Waterheater Trust bond in the search above is looking good.
i actually managed to find the prospectus on sedar.
it is A rated and the company owns rented water heaters in the central Ontario area, mostly GTA.
small company though


----------



## scomac (Aug 22, 2009)

SixesAndSevens said:


> can you pl. explain this a bit?
> what do you mean by cost to stay short?


Sure. This subject was recently covered in _The Wealthy Boomer_ blog.


Don't mess with your strip-bond ladder, Bob Cable advises.


----------



## SixesAndSevens (Dec 4, 2009)

scomac said:


> Sure. This subject was recently covered in _The Wealthy Boomer_ blog.
> 
> 
> Don't mess with your strip-bond ladder, Bob Cable advises.


I see, so the recommendation is to build a 5 year ladder using strips.
But as you yourself noted earlier, it is hard to build a ladder with smaller portfolios.
Most of the high quality strips come in $10,000 lots.
So at the very least, the portfolio has to be $50,000 to do this.

Building 5 year ladders with GICs suck as well because of very low rates by the major banks.

So what's the recommended way of building strip bond ladders with smaller portfolios?

Is there an ETF that accurately implements this strategy?


----------



## scomac (Aug 22, 2009)

SixesAndSevens said:


> Is there an ETF that accurately implements this strategy?


There are a couple from Claymore Investments; Claymore 1-5 Yr Laddered Government Bond ETF  and Claymore 1-5 Yr Laddered Corporate Bond ETF. Both are ETFs that roll a ladder of coupon bonds rather than stripped bonds, but that is largely irrelevant especially if you select the DRIP plan to reinvest the distributions.


----------



## SixesAndSevens (Dec 4, 2009)

scomac said:


> There are a couple from Claymore Investments; Claymore 1-5 Yr Laddered Government Bond ETF  and Claymore 1-5 Yr Laddered Corporate Bond ETF.


Cool.
these are very recent though, the CBO only started earlier this year.
so is this what most folks on here are doing for their bond investing?
what was everyone doing prior to these ETFs?


----------

