What Are We Really Looking at on the Runway?

Until tonight, this is Fashion Week in New York. It's that lovely semi-annual extravaganza where big white tents take over Bryant Park and women trip over their heels just to get a glimpse of next season's looks. This was especially meaningful since it was the last time Fashion Week will be based in Bryant Park. The September shows will be held in Lincoln Center, tear, sniff. I was lucky enough to attend 2 shows this weekend. The first was men's designer Simon Spurr on Sunday where with a few friends I watched and picked out what I liked and didn't like and then chatted about the looks over brunch. The second show I went to was Monique Lhuillier (ready to wear, not bridal) where again I could see what I liked didn't like but in addition I went with a friend who is a designer and could verbalize specific trends and styles. Basically after listening to my designer friend discuss the different elegant looks that strutted passed us, I realized that without knowing the specifics of a dress and how it is made, one cannot know whether or not a dress would truly be a good fit for them. This holds true for bonds as well. While you may like the look or yield of a bond, without knowing the specific details, how can you tell if it's a perfect fit or something that will make you look dowdy or default? Below are the details of bonds and what each part means to you, the buyer.

Every bond has a coupon, it may be zero, but either way it is fixed at the time of issuance. The coupon is what you are paid out every year. If the bond has a 0% coupon, you buy it at a discount and the interest compounds on itself as though it were paying a coupon and you get all your interest at maturity. A bond's maturity is it's ending date. That is the date you get your principal (face value of how much you originally bought) back. A bond's call date is when the issuer has the option to call the bond in (usually at 100) to give you back your principal early and stop paying interest. Once a bond hits its call date, the issuer has the option to call the bond anytime after that with 30 days notice to the bond holders. Some bonds are non-callable which is usually advantageous to the buyer. Bonds have 2 forms : Book Entry and Registered. Book Entry just means that your bond is held in electronic form so you don't hold the actual paper and have to worry about losing it. Nearly all bonds are in book entry form now. Bonds that are Registered have the option to be printed on to actual documents you can hold. The powers that be are not a fan of this because it is difficult to track and now charge at least $150 just to have your bond printed. Not worth it in my opinion. Moodys and S&P (Standard and Poor) are the 2 main rating agencies which will tell you what your bond is rated from AAA all the way down to NR. A third rating agency is Fitch which actually keeps ratings up to date a little more than the other two. The last and most important facet of your bond is your yield to worst. This is your true yield on your investment. Whether you paid a premium (above 100) or a discount (below 100) your SEC Yield/Yield to Worst is what you want to know. If the bond is a premium, your yield to worst is the yield to call and if your bond is a discount your yield to worst is the yield to maturity.

Once you take a look at the details of a bond and know what each mean to you, looking over each part is like trying it on. If you like what you see, make the purchase. If you think it's a little too long and would need it hemmed a bit, you might want to wait and see what comes around next time. Moral of the story is, you can't just buy a bond because of it's pretty color (yield).

Converse are to Mizunos as Bond Funds are to Bonds

At some point Converse sneakers were considered acceptible athletic wear for actually playing sports. Since then, the sneakers have morphed into comfotable gear to thrown on for a walk on a Saturday as opposed to a work out. Instead, through some genious engineering, we now have sneakers like Mizuno to break a sweat in. It's almost laughable at this point to picture someone participating in any athletic even while wearing their favorite Chuck Taylors. We simply know better now. Some sneaks are for strolling while some are for really workin' it.


When it comes to investing our money, we never actually want to be strolling because let's be real, we work hard for our money and our money should be workin' it hard for us! Basically Converse which in this case can be thought of as bond funds aren't the best way to get some muscle outta your money.


When you buy a bond fund, it is comprised of a bunch of different bonds. The broker presenting this fund rarely knows what the specific underlying bonds are in the fund so basically has no idea what he or she is putting your money into. When you buy an individual bond, you know exactly what is paying your interest and how. Bond funds also do not have a specific maturity date (day you get your principal back). This means that when you put your money in a 7 year bond fund, 5 years later you still own a 7 year fund. When you put your money in a 7 year individual bond, 5 years later you have a 2 year bond. If you need to sell, an individual bond is much better because a 2 year bond that has the same quality as a 7 year bond is always more expensive. This is due to duration risk. The longer the bond, the more time there is for something to possibly go wrong with it. Costs are a third consideration. Generally when you buy a bond fund, you end up paying a fee on it every year which really eats into your profit. When you buy an individual bond you pay the ask price while the broker selling it to you paid the bid price the spread is the only profit in it for the broker. Being a bond salesperson, if I thought bond funds were good investments, I would most certainly sell them because they are incredibly profitable (for the broker) and there's not much I love more than a new pair of running sneaks! The problem here is that when investing your money, you want it to be most profitable for you, not your broker or brokerage house.

Moral of the story is while it was fine to excersize in Converse when we didn't know any better, now that we know about more supportive shoes, our ankles and toes love us more. The same goes for bond funds, now you know better, so get your money into some stable sneaks (bonds)!

Wear it, Wash it, Throw it Away : Work it, Earn it, Give it to the Government

I pretty much think it's common sense that when you buy a $10 shirt or dress pretty much anything from either Forever 21 or H&M it's not going to last as long as a piece of clothing that was made with higher quality material and therefore is more expensive. While these clothes are fabulous and every Spring you can catch me at Forever 21 stocking up on their comfy inexpensive sundresses, I don't expect these items to last more than one season. The stores don't actually come out and say that their clothing is of less quality than say a Ralph Lauren shirt or dress, but from the cost and material the clothes are made of, sometimes we have to draw conclusions from the facts at hand.

A couple months ago, I posted about how taxes are going to be raised a lot come 2011. Considering the White House has taken the stand that nearly everyone is wealthy now, these taxes are going to hit any individual making over 200k/year and joint income of 250k/year. While this is the first time the White House has come out and said that taxes are going to be raised, like the H&M shirts, this is the type of thing we need to have a little foresight with. That being said, if you are in that range, I'd start buying tax free bonds as soon as possible because they are going to be worth a lot more to you when your tax bracket is in the 40%-50% range. Just to give you an idea, in the highest federal bracket now is 35% the taxable equivalent on a 4.5% municipal bond is 6.92%, once your bracket is raised to maybe 45% that same 4.50% will be equivalent to a 8.18%. AND the bond (if you buy quality) will definitely last you longer than any bargain dress you get!

If You Don't Get It, Don't Buy It

Recently a client of mine called me and asked me about a bond fund that his other broker was telling him about. When I researched the fund, the actual way the fund works, it is almost laughable that this type of security exists. If you went to a store and bought a pair of jeans and the sales person told you that these are the best type of jeans but if (or when) they fall apart we'll give you another pair and if that pair falls apart we'll just give you another one, would you buy the jeans? I say probably not because how is this jean company going to have the money to keep replacing your decayed jeans when you only bought one pair to begin with? This is the same idea when dealing with securities. If you don't understand how an investment is going to pay you, or it doesn't make sense logically, then it's simply not a solid security. When you invest in a security whether it be stocks or bonds, your broker should be able to tell you exactly what will be paying your dividend/interest. If he or she can't explain it in terms that you understand, don't buy it.

This particular fund was supposed to pay out 2.65% and was rated AAA. When I looked at the individual bonds that made up the fund, nearly all of them were no where near AAA quality, in fact, 20% of the fund were bonds that were rated below minimum bank investment grade (Baa3/BBB-). I called the company that put the fund together and asked how this fund had a AAA rating. The woman I spoke to explained to me that the fund starts out with a AAA rating, if it gets downgraded to AA, the payout instead of being 100% of 2.65% it will be 110%. She then told me that if it gets downgraded again to A the fund will pay out 125% and then 150% if it gets downgraded to BBB and then it will pay 200% with a BB rating meaning instead of paying out 2.65% it will pay 5.30%. I asked how this was possible because if the fund gets downgraded, it probably means that one of the bonds within it went bad, and therefore is not paying so where are they going to get the money to pay the holders the extra yield promised? It simply doesn't make sense. As an example, if there are 10 bonds that make up a fund and they each pay $10 so the investor is making $100 off the fund and one of these bonds goes bad and the fund is only collecting $90, how is it going to pay the investors $110? Where is the money supposed to come from?

This is exactly what got the securites industry in a mess to begin with, people were buying these Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs) without a clue as to what was paying their interest. Even the brokers didn't know exactly what they were selling! The broker that presented this fund probably only knows that it's a bond fund and rated AAA, that's it. Everyone thinks finance is an area that's very confusing but that's only true when your broker doesn't understand the security they're presenting and therefore can't explain it to you.

The moral of the story is if you don't understand how a company is going to continue to give you new jeans to wear when the ones have keep falling apart and you only bought one pair, then what's probably going to happen is the company will go out of business and you will be left pants-less.

When in Doubt, Run the Other Way

When our entire economy came crashing down around ours ears, the only businesses that were shaking in the boots more than the real estate companies, was the retail industry. Between Barneys, Saks, Bloomies, and Bergdorfs sales have been running rampant. Nearly every brand that these stores carry took the approach of marking down their covetted items. I loved the sales but the problem was as a buyer I started thinking, if I can get these shoes 50% off, then why not wait to buy them until they're marked down to 70% off? So while there were great deals out there, the companies that were in competition to mark down their product more than the next company, didn't realize that they were devaluing their product. If I can buy a $500 pair of shoes for $200 or $300, why would I ever again spend $500 on this type of shoe? Nearly every single one of these companies that took the frantic mark down approach had dismal earnings last year. The only company that stood out among the rest was Hermes. Instead of focusing on marking down their items, they kept their prices the same and produced ads about how well made their lines of clothing and bags are instilling an idea how buying a product of theirs is an investment. Since it's so well made, the product will stand the test of time and therefore be worth whatever extravagant price. As a result, Hermes was one of the only high end brands whose earnings didn't tumble in 2009. As an investor, you should take a note from Hermes and not follow the crowd as they franticly buy super short term investments for fear of inflation.



Right now short term municipal bonds are yielding incredibly low. The reason for this is that since everyone thinks there's going to be massive inflation, they don't want to have long term investments where their interest won't be worth much so the demand for short term bonds is through the roof! The only problem is, there isn't actual inflation happening and there won't be until our employment figures start to turn around. Traditionally when inflation happens, the price of lets say milk goes up so the worker tells their boss they need another dollar in their paycheck to pay for this milk, the boss raises the salary causing wage inflation which in turn causes true inflation. What's been happening now is when the employee asks the employer for another dollar in their paycheck to afford the rising price of 'milk' the employer can't give it because then the company won't be competitive with all the other companies worldwide. Moral of the story is the employer closes up shop, letting all the employees go and opens up a shop in China, Vietnam, or wherever else he or she can for less money. This has been happening for the past 10 years and until we figure out a way to get employment on the rise, inflation is not a serious concern. My advice is to be like Hermes, go the other way. Invest in medium term bonds (10-15yrs out) to take advantage of what yields you can while not going out too far so you'll be prepared for when inflation does actually hit.

Do Bonds Die?

While usually my posts have been silly and fun this one touches on a bit of a more serious topic. This week a close friend that I grew up with lost her Mother to brain cancer. The saddness and frustration I feel can't be put into words on how this insulting disease took a vibrant woman from our world. When thinking about how to cope with this, I realized the best way is to think about how Anita Friede is still with us. Her certain nuances, sense of humor, way with words and style savvyness live on in her daughters. Also the memories from people who's lives she touched keeps her with us. While the feelings an investor will feel when losing an investment cannot compare to losing a loved one, when a bond defaults it usually ends up sticking around in the same way that Anita will.

The default rate on municipal bonds is extremely low to begin with but if you look at the default rate on general obligation bonds that are rated minimum bank investment grade (Baa3/BBB-) the default rate is less than 1%. The only state general obligation bond that has defaulted in the past 100 years was the state of Arkansas during The Great Depression. Typically when a bond defaults, it will miss an interest payment or two and then will end up paying off in arrears meaning that the bond will pay it's interest late and will also pay interest on the lapsed time. Basically more often than not once a bond has "hit the D" it still lives on and pays off in full just a little late. This was the case with Arkansas in the 1930s.

A number of small towns default on bonds every year. Mainly these towns are unrated because the issue of bonds was so small they didn't want to pay for a rating. The reason some of them default is usually due to the fact that the town had an unexpected expense that it had to pay off first and then could continue paying it's interest.

The moral of the story is when a bond defaults, don't panick, it's likely that you will end up getting all of your principal and interest back just a little later than expected. I can only compare this to Anita because she left such a mark on the world that even though she has phyisically left us, those who knew her will benefit from their time with her in the years to come.

The January Effect, Not Exactly a Post-Holiday Sale

While January for most of us brings the uphill battle of working off all the food and cocktails of the Holiday Season, a little bright side are the post-holiday sales. That blender you weren't hoping to find under the tree can be exchanged for an item that orginally was worth even more than said wonderous blender. Or maybe you're like me and were holding out to get those shoes until they went on sale after the holidays. Either way, January is usually a month to take advantage of marked down items. Unfortunately this happens everywhere except the bond market. "The January Effect" as it's become known is due to the fact that January is the most expensive month to buy a bond. The basic reason for this is the supply-demand ratio is off, demand for municipal bonds takes a big jump in January.

Most large companies close their books the last 2 weeks in December so that when January First rolls around they have a ton of cash on hand. They need to put that money to work so these large companies start buying up bonds by the handful (which really means by the million). This puts quite a dent in the supply of bonds on the market.

Aside from the large institutions buying up bonds, there are a lot more bonds that mature in January as opposed to any other month. So in addition to the institutions needing to place their cash in bonds, after having their bonds called or mature, individuals need to replace that money too.

Since January is a big month for maturities and calls, it stands to reason that it is also a large interest paying month. Again, people are looking for bonds to place their interest in.

The best thing to do if you know you have a bond coming due in January or expect a large interest payment is to look for a bond in December and ask your broker for an extended settlement date. This way you can take advantage of the Holiday bond sale in December (AKA people selling their bonds for tax loss purposes). Happy bargain hunting!