Bonds Offer Investment AlternativeThe DM News Portfolio tracks stocks, shares of a company that can be purchased by investors who stand to gain from a company's strong performance in terms of revenue, income and other widely publicized indicators. Although you would never know it by the attention paid to the Dow Jones Industrial Average and other stock market indicators, buying stock is not the only way to earn returns on investment.
Bonds are an alternative for investors looking to diversify their holdings with vehicles that deliver more predictable returns than stocks Both public and private companies issue bonds to finance operations, fuel expansion or achieve other financial goals.
"Bonds are a form of financing the company. We finance through a blend of debt and equity," said Andrea Robertson, assistant treasurer for commercial printer R.R. Donnelley. "Bonds are a lower cost of financing that attracts a different investment base."
By purchasing a corporate bond, you are lending a company a fixed amount of money in return for interest payments over the period of the loan and the repayment of the loan, or principal, on a specified maturity date. Bonds, or fixed-income securities, are attractive to corporations because interest payments are tax deductible while stock dividends are not.
A screen of the Moody's Bond Record identified 10 companies in the DM News Portfolio in addition to R.R. Donnelley that have corporate bonds outstanding: American Business Information (InfoUSA), Big Flower, Corporate Express, Fingerhut, Metris, Mail-Well, Shop at Home, Sitel, Valassis Communications and World Color Press.
Bonds are rated by investment risk or the ability of the issuer to pay back a debt obligation. Generally, the greater the risk the higher the return, or yield. Donnelley bonds are the only ones in the portfolio with an A rating, which indicates good financial security. The rest fall into the Baa to B categories, which rate their ability to pay back debt as adequate to poor.
Bonds offer returns in two ways. Holders are paid interest on a regular basis, which is expressed as a percentage of the bond price often called the coupon rate. A $100 bond yielding 6 percent would pay $6 in interest every year. Should the price of the bond change, however, the yield changes. As bonds rise in price, the yield declines and vice versa. So, the second way to earn a return is to have the bond price increase.
A change in interest rates can also affect the performance of bonds. If rates rise above the rate on the bond you are holding, you lose out on a higher yield. But if rates fall, your bond becomes more valuable. Bonds also can be called, or repaid by the issuer, prior to the date of maturity, which eliminates future interest payments.
Despite these risks, John Lonski, chief economist and managing director at Moody's Investors Service, New York, said now is a good time to invest in corporate bonds. Historically, corporate bonds yield one percentage point higher than the benchmark 30-year Treasury Bond. Right now the spread stands at 1.4 percent.
"If Treasury bond yields don't rise much, I expect corporate bonds will rise more rapidly," Lonski said. "Corporate bonds can be viewed potentially as a better investment if the yield is above the long-term trend of Treasuries."
Corporate bonds can be purchased individually through a broker, but Lonski cautions against this strategy for all but the wealthiest investors who can afford to buy large amounts of bonds. This is because institutional investors tend to get a much better price for a bond.
Lonski and Robertson both advise purchasing bonds through mutual funds. Funds that contain the words "income" or "high-yield" usually own corporate bonds. All the major fund companies sell bond and income funds. Short-term corporate bonds called commercial paper -- which generally mature in 30 to 270 days -- are a primary investment in many money market funds.
Although Robertson cautioned that locating specific bonds within a fund is difficult because of turnover and the description of the issuer, the Vanguard High-Yield Corporate Portfolio contained bonds from Big Flower and World Color Press while Fidelity High Income contained bonds from Sitel and Corporate Express, according to their latest annual reports.