This is not really a contemporary subject but one to keep in mind for when bond opportunities arise. Graham in his book, the Intelligent Investor, discusses how sometimes second grade bonds, or what we would now call high yield or junk bonds trade at extreme discounts to their maturity value due to changes in interest rates and due to the change in the perception of risk. The junk bond yield has significantly increased over the past few months but is still far from opportunity territory as it was the case in 2016, 2011 and especially 2009.
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The Intelligent Investor - Chapter 6 Summary - Bonds And IPOs
Good day for investors. Today we continue with our Book summary of the intelligent investor and we discussed Chapter 6. However if you are interested in a more more modern perspective on value investing please check out my book on Amazon modern value investing. The link is in the description below where I discussed 25 tools how to analyze companies in addition to modern perspectives on portfolio strategies. Chapter 6 of the Intelligent Investor discusses junk bonds foreign bonds and new issues stock IPOs. So junk bonds. This is really not contemporary now because the interest rates on junk bonds are really low when compared to other interest rates. So there is a huge risk because those interest rates expand and there is little return because you're not going to risk that much for investing in junk bonds. Let me show you. This is the U.S. high yield effective yield and you can see that now it is at six point eleven percent but in 2016 it went to almost 10 percent in 2012. Again it went to 10 percent and during a real recession it went to 23 24 percent and that's when you have to buy those junk bonds. Not when things are good. You have to buy them when things are bad. What's very interesting that the Graham tells us how all the junk bonds suffer severe sinking spells in bad markets. But most of them recover when favorable conditions returns. So this is really crazy. Nothing has changed since the 1960s 50s 40s junk bonds go hugely up hugely down. And you can read bad market conditions.
You can buy them really really with the huge discount. So given the low interest rates now and if we see interest rates expand we can really see those bonds those junk bonds be bought at huge discounts when a bad market comes and then it is the time to look at junk bonds. Look at what the probability of default. Finding those that don't have default or that those have a margin of safety and then investing for now the risk is too small for the reward. But if you're just patient and you wait for the normal market cycles you will find that opportunity just to show how an increase in interest rates affects the bond. This is the yield on Tesla's bond which means that investors are now scared for the risk of law and the bond is much cheaper than it was when it was issued with a 5.5 percent yield on foreign bonds. Graham is completely against foreign bonds but then you have to see OK how that fits your portfolio your portfolio diversification and whether you need to be exposed to currency risks or not. If you live in one country you might want to stick to those country yielding bonds. If you don't like global risks that's something that's a personal preference and foreign bonds are different than foreign stocks because a business is a business and the bond has much more risks because all those risks are fixed like currency risk interest rates etc. etc.. So keep that in mind. Now what about IPOs. Graham really doesn't like IPOs from a general perspective. But he says that in a bad market times there could be opportunities in IPOs.
Then when the bull market somewhere in the middle of the bull market then IPOs are fairly priced and in the late stages of the bull market IPOs are extremely overpriced. So if you look at the IPO as you might want to wait a little bit that they are more fairly priced and that's what we have seen happening with snap chat. However in the early stages of the bull market just think of Facebook the is we're OK priced but even then Facebook stocks first drop almost 150 percent only to rise to the current levels. So be careful with IPO. You can perhaps always wait or invest in stages to get to lower energy prices because those are usually very very volatile environment. Further when the IPO is done. Always keep in mind that the bent bank promoting the IPO gets a fee between two and eight percent. So there will be very very positive on promoting that to get the high fees as possible. Therefore I don't like to invest in IPOs. I like to invest late or if the story is the same but the market stops liking it. So I usually look at an IPO free six months later or after the lock in selling period from the management has passed. So something to think about. Graham says also that we have to look at IPOs later when there is really a margin of safety and when those become a bargain the morrow of this chapter is that in the market nothing changes the same cycles happen over and over again. There is enthusiasm about high yield. People take a lot of risk for a little bit higher healt.