2021 has been a difficult year for investors who have built a bond ladder

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(This article was co-produced with Hoya Capital Real Estate)

introduction

“Dear Sir: Say goodbye to another of your well-built ladder steps.” The emails weren’t that nice, but I got the message 8 times in 2021, forcing me to replace 50% of my laddered assets. Thanks to the assets reviewed here on Seeking Alpha, I was able to maintain my valued scale at nearly $ 100,000.

Here are lists of assets held during the course of 2021. For assets with a future call date, I calculated the YTC using year-end data points. Most have a due date and for these I provide the YTM. Both have been declining since early 2021, with weighted values ​​now: YTC: 3.5% – YTM: 5.5% – Yield: 6.5%.

These are the assets that have been called or expired.

Source: Miscellaneous as compiled and collected in Author’s Portfolio XLS

These are the ones we had at the end of 2021.

Source: Miscellaneous as compiled and collected in Author’s Portfolio XLS

Review of selected assets

Due to its growing size, I have decided to discuss only a subset of the assets held which I believe present an interesting fact that should be highlighted. Everyone in the scale, with the exception of JEMD CEF, can be found at www.quauntumonline.com.

COE.PA

Source: quantumonline.com

the Wesco PFD A (WCC.PA) was issued in connection with their acquisition of Anixter International Inc. in 2020. While Wesco was in a bidding war, the 10.625% coupon was to win over Anixter shareholders. When it starts to float past the first call date, the landline is still a whopping 10.325%, making it almost certain that it will be called in 2025. WCC.PA traded between $ 30- $ 31 during the call. most of the past six months, which, if called after 6/22/25, would result in a “loss” of $ 5-6. Every now and then I calculated the YTC and it stayed correct. Now at around 3.6%, this is one of the lowest YTCs I own. Since the price traded over $ 31, I have a GTC sale of $ 30.99 on my 100 shares.

CSSEN ticker

Source: quantumonline.com

This Chicken Soup for the Soul (NASDAQ: CSSE) To note (CSSEN) has the lowest YTC by far, due to a price of $ 26.10 and a possible call this summer, but the YTM is above 8%. This is a good example of trying to decide the odds of the show being partially or fully called up in six months. Here are the things to consider:

  • Even with a YTC of 1.83%, it’s better than cash. What will you do if sold?
  • The CSSE has a PFD (CSSEP) which carries a slightly higher coupon (9.75%) and can be recalled 11 months later. With cash tight, the CSSE might wait and call this problem instead.
  • Operating profit was – $ 39 million in the past 12 months. Calling that note would only save $ 1.995 million, which wouldn’t make much of a difference. Also, unless they issue a new note, they would need $ 21 million to completely call the note.

With money needed to expand their video content, PFD being a smaller issue with a higher coupon, I put the odds of a call this summer as low. If the market thinks otherwise, the price should start to fall, while the PFD remains more stable; Something to watch out for.

Source: quantumonline.com

This Travel Centers of America (AT) To note (TANNI) has been redeemable for six years this month. TA also has two 8% notes that mature later but are also callable, so if one is called it would logically be TANNI. Here, operating profit would double if all three tickets could be redeemed. Except that would require almost 10 times what TA is currently generating from operations. With COVID restricting travel, their operations are still affected. With a YTM of 6.8%, I think the risk is worth it. About 9 months of interest covers the potential price loss, so keep from here betting on a no-call until 2023.

Source: quantumonline.com

For the last one that I will see again, I chose the Eagle Point Series B PFD (ECCB) because it just ended a call 50%, which means there is a high chance that the rest can be called. ECCB goes “ex” for $ 0.161458 around the 10th of each month so that an investor can calculate what their net would be if called. The market is not afraid of a second call as the price has risen by around $ 0.40 since the call was announced and the current buyer would experience a loss of around $ 0.30, after interest. I covered my thoughts on the ECCB in a recent article: The ECCB makes a partial call: what now!

Portfolio strategy

Graphic
Data by YCharts

While most of the assets available to build a scale are rated BB or unrated, my assumption for including the chart above is that their YTMs should follow the corporate BBB rate more closely than other available rates.

With 5-year CDs yielding less than the Fed’s 2% inflation target (1.5%), investors looking to diversify beyond the stocks in their portfolios are forced to take risks of interest and / or default rate. Depending on what their need for income is coming from that part of their portfolio, this will influence the type and amount of each risk they have to accept.

Both risks can be controlled by holding funds that hold different asset classes. Closed-end fixed income funds or high yield ETFs would be of interest to fixed income investors. Using funds reduces the risk of default and choosing a fund with a short duration can reduce exposure to price depreciation when interest rates rise.

Individual preferred stocks with no maturity date and with extended first call dates can provide known income streams and YTC values. If well researched and with good equity hedging, the risk of default can be minimized. Bonds all the more so as they are higher in the capital structure.

The idea of ​​strategy behind building a fixed income ladder for me was to limit interest rate risk. While I also own several fixed income funds that cover this spectrum of assets, with rates at historically low levels and inflation on the rise, I wanted some exposure where that risk was traded for the other risk: default. . I limit the risk of default in two ways. First, by currently limiting any individual holdings to $ 10,000 and having an issuer limit of $ 20,000. Second, I try to own between 10 and 20 different issues spread across multiple issuers and types of business.

Final thoughts

As rates start to climb, I expect several things to happen that make the ladders easier to maintain. First, redemptions via Calls are expected to slow down as issuers see less savings by exchanging a new issue for an existing one. Second, existing prices should start to fall. As you approach Par, locking the higher YTCs should become easier.

You can reduce the risk of a call by looking for issuers with multiple investment choices and not picking the highest coupon, especially if both are now redeemable or are approaching their redemption date.

There are two ways you can reduce the risk of default. The first is to invest in the Notes before the Preferred Securities, as they are expected to be higher in the capital structure. Second, look for issuers that have recently entered the market with a lower coupon than previous issues. While the level of rates affects this each time, so does the market’s change in its assessment of issuer risk.

Previous articles on this topic

August 20: Build a “CD” ladder using baby bonds

February 21: dissect the assets I use to build a fixed income ladder

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