High Yield: Playing for Pennies, Risking Dollars

High Yield: Playing for Pennies, Risking Dollars by David Merkel, CFA of Aleph Blog

I try to avoid investments where the upside is limited, but the downside is unlimited.  That’s the way I feel about junk bonds now.  Have junk yields been lower before?  No, we have eclipsed the time in 2003 when the junk market was in a yield frenzy, until Bernanke uttered the word “taper.”

There are a lot of desperate retirees seeking income, assuming it is free, and not merely a return of capital.  There are a lot of desperate people seeking certainty in investing and do not realize that dividends are a handmaiden of value, and not value itself.

There are a lot of desperate pension plans looking to make up for lost time, and hoping against hope, buying dividend paying and growth stocks, high-yield bonds, alternatives like hedge funds, private equity, etc., at the wrong time.

Those are the things you should buy when stocks are cheap and people are scared to death.  You sell them when people are confident, and valuations are high.

Valuations are high; not nosebleed high as in 2000, but high as in comparable to the peak in 2007.  Could things go higher?  Yes, but you are playing for pennies and risking dollars in the process.  Those with a value and quality discipline will likely fare better in the process, but markets are messy, and what actually happens will be a surprise.

Thus I would encourage you to consider the credit quality of your stocks and bonds.  What kind of shock could they withstand?  When yields are low, like they are now, the system is less resilient to credit crises.  Be aware, and be on your guard.



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.