Worthy Credits

By Tom Sullivan, Barron's, 11.20.06

IT WAS BOUND TO HAPPEN: Boomers are flocking to bonds the way they once took to Hula Hoops. As they settle into their 50s and 60s, these folks are trying to reduce risk in their portfolios and increase income. Bonds can do the trick -- but picking the right ones requires some care.

The uncertain outlook for the economy doesn't make it any easier. If growth weakens much, bond defaults likely would pick up. If growth picks up, inflation could erode bond values. And right now, both corporate and municipal bonds offer relatively low yields -- about as close as they've ever been to those of no-risk Treasury bonds, amid record-low defaults and easy lending by banks.

But there are still some real winners out there. In fact, we found seven compelling bonds, ranging from super-safe paper of companies enjoying the implicit backing of the federal government to the high-yielding, attractively priced "junk" of home builder K. Hovnanian.

Our favorite -- because of its stellar credit ratings, a relatively juicy yield margin over comparable U.S. Treasuries and a $26.9 billion endowment fund -- is a long-maturity taxable issue from Harvard College, yielding 5.92%.

These bonds, maturing in 2037, are likely to become what market pros call "museum pieces" -- investments you hang on to for years because of the returns and the cachet. In fact, they have traded infrequently since they were issued in May, so you may need the help of a major brokerage house to track some down.

The Harvard securities are part of a category known as taxable munis -- bonds whose issuers have a public purpose, even if they're not a city or a state. Taxable munis, which often yield more than corporate bonds, "have become a lot more liquid over the last 10 years but are still not as liquid" as tax-exempt munis, says Ken Woods, chief executive officer of Atlanta-based Asset Preservation Advisors.

Fortunately for investors, hunting down bonds, evaluating them and trading them generally has been getting easier. For one thing, the National Association of Securities Dealers requires that details on corporate-bond transactions be reported to its computer system for public dissemination within 15 minutes after a trade is made, providing price information that wasn't available just five years ago.

Bonds are now available at online-trading sites, including those of big firms like Charles Schwab (www.schwab.com). Earlier this month, J.W. Korth & Co. launched Bonds4sale.com, which it bills as "an eBay-like auction process for bond holders to sell their bonds online at the best possible price." Its sister site, Shop4Bonds.com, was launched in 2003, and has "grown very substantially over these three years," says company founder Jim Korth.

The hunt for good bonds often leads to tax-exempt munis. They're usually rock-solid because states and municipalities, unlike corporations, simply don't go bankrupt. People in high-tax states are drawn to munis because bonds issued in the home state are exempt from federal and state taxes. If you're from other parts, the juiciest pickings can usually be found in the seven states without income taxes -- Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. They need to boost yields to attract in-state buyers in the absence of a state-tax benefit.

	Income for All Seasons: There are good bonds to be had for both cautious and adventurous investors. Here are the ones we like the best.

In muni land, there is "a rule of thumb that if you're in a state with a state income tax of 6% or less, you can find something out of state" for your portfolio that might be offering better value, says Daniel Genter, chief executive officer of L.A.-based RNC Genter Capital.

A case in point: a recent $234 million offering of general-obligation bonds from the city of Dallas, which was priced with a top yield of 4.43% for bonds maturing in 2026. That's the equivalent of about 6% or 7% on a taxable bond, depending on your tax bracket. And the city actually carries a higher credit rating from Moody's Investors Service than Texas' Aa1.

Another solid bet is debt from triple-A-rated mortgage giants Fannie Mae (ticker: FNM) and Freddie Mac (FRE). Freddie recently priced $3 billion of three-year reference notes to yield 4.868%. That's almost one-quarter of a percentage point more in yield than comparable Treasuries for bonds from a quasigovernmental agency.

"There's more value with agencies than with corporate names," says Marilyn Cohen, president of Los Angeles-based Envision Capital Management, who likes shorter-dated agency maturities but warns investors to be aware of their call features. If interest rates begin to fall, there's a good chance the agencies will refinance, meaning you'll lose the bond.

While Barron's has turned cautious on Wal-Mart Stores' stock (WMT), we like its bonds. Its 6.875% bonds due 2009 were recently yielding 5%. "Sales growth may be slower, but the credit quality is practically invincible," says Carol Levenson, director of research firm Gimme Credit.

MOVING INTO RISKIER but potentially more rewarding territory, Kraft's 7.55% bonds due 2015 are standouts. This company, formerly Nabisco, is a reliable money machine, with plenty of cash to pay its coupons. And its sheer size makes it an unlikely candidate for a leveraged buyout, the bane of the corporate-bond investors, because the added debt puts pressure on credit quality.

The Bottom Line It's generally gotten easier for investors to find, evaluate and trade bonds. Cautious investors should consider munis, and the paper of mortgage giants Fannie Mae and Freddie Mac.

The company and its bonds also could be helped from its pending spinoff from Altria, formerly Philip Morris. "We believe the pending split-up of Altria and Kraft will eventually put some distance [between Kraft and Altria's] ongoing tobacco-litigation risk," says James Goldstein, an analyst at research firm CreditSights.

In the junk-bond market, the drubbing K. Hovnanian's bonds have taken due to the housing slowdown looks overdone, given management's strong control of the balance sheet. Research firm KDP Investment Advisors, for one, has Buy on the bonds. "It's a bet [that assumes] we're in the trough of the housing market," says analyst Matt Wilcox. Hovnanian's 7.75% bonds due 2013 started the year at a price of 100½ ($1,005 per $1,000) of face value, hit a low of 90½ in July and were recently quoted at roughly 96.

The last pick is only for the gutsy: the 8% notes due 2031 of General Motors Acceptance Corp., the finance arm of auto-giant GM. GMAC will soon be majority-owned by a private-equity consortium, and Moody's last week said it would confirm its Ba1 long-term rating, its highest on the junk scale, when the deal closes. Says Kim Nolan, head of high-yield at Gimme Credit." MAC won't regain its investment-grade rating anytime soon, but when it does, based on where other investment-grade financial services are trading, there could be good upside on these bonds."

So, whether you're cautious or bold, there's a bond out there with your name on it.

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