Blogs On A Plane: Special Bonds Are Blowed Up Edition

I wrote most this post on a plane back from Molokai. We went for a short trip, with our psychology being to not want to think we spent too much time in a place where there's less to do than places like Maui. We ended up doing a lot of chilling on the beach, beaches that we mostly had to ourselves. This post looks at several interesting articles in the current Barron's.

A quick hit article on HSAs which have evolved to be more of a mainstream type of health insurance offered now as a benefit to employees. My wife and I started adding to an HSA pretty much when they first came to exist but it has been a few years since it made economic sense being self-employed. The various plans available where I live are not cheaper despite having high deductibles, so we haven’t contributed for a while. I’ve mentioned before our having what amounts to catastrophic insurance which we’re able to get away with for now, hopefully all the way through to Medicare unless HSAs become a little more economically friendly. For us, the insurance would cost $1400-$1500/mo plus then the $8750 into our HSA account versus now spending about $750/mo. Your mileage may vary but make sure it makes sense before you just jump in. 

Andy Sewer took a fun, but very brief look at 100-year bond issues sold by universities inspired as Andy frames it by Disney issuing sleeping beauty bond in 1993, Sewer didn’t say if they were 100 years bonds or not, I’m trying to remember and off the top I would guess they were 50-year bonds. I was curious to read who issued 100-year debt when rates were crazy low and the only one mentioned was University of Virgina which sold 100-year paper in 2019 at 3.23%. I don’t have a Bloomberg to price these but I’m thinking if there’s a market for them, they have to be 30-35 cent on the dollar. Yikes, but they’ll get their money back at…., wait, never mind.

Jack Hough wrote about Analy Mortgage (NLY). It is currently yielding 17% after dropping in price in this latest lift in interest rates and recently the dividend was cut which Jack notes, there have 16 cuts in the last 16 years. We’ve talked about mortgage REITS a few times including Analy. It seems like it has always been popular because of the very high payout. In looking at it every so often to see how it has done (I’ve never owned it for clients) it seems like it’s done well, price-wise about 1/3 of the time and gotten pasted the other 2/3 as a very casual observation. Taking Jack’s word for the 17% (I’m on a plane as I write this), we are now in a 5-6% world and this thing is yielding 17%. I’m not saying to buy or not buy it just trying to point out what holders might be in for if they do hold it which is a wild, wild ride. I could see someone collecting the 17% for a year, the name drops 20% which is easy for this one, and then selling out. I think it needs to be thought of as ride or die type of holding. Great if that’s you and the actual merits of the company check out but it seems like it would be a very difficult hold.

Talk about a difficult hold, Barron’s checked in on the Fairholme Fund (FAIRX) which has long been run by Bruce Berkowitz. I probably wrote about this one a couple of times back in the first iteration of this blog. FAIRX is 82% invested in Florida real estate developer St. Joe (JOE). This year, its performance has it the top 1% of mutual funds but in “2021 and 2022 it was ranked in the bottom 100th percentile.” It has long been a very concentrated fund. As I sit here writing on the plane, I seem to recall it got caught with a lot of the old Fannie Mae or maybe Freddie Mac when the crisis hit. This thing really is a wild ride. Barron’s made a great point of asking why pay 1% to hold a proxy for JOE, when you could own Joe directly? Not addressed was why it is ok for a fund to have 82% in one name. It must be ok, I’m just surprised that it is. 

A big priority in my life has been know where to deviate from the crowd. Here I am talking not just portfolio management but overall lifestyle, habits and choices and yes this does filter into my day job managing investment portfolios. Mark Baker applies the word orthogonal to what I am describing. So it is today with bonds. Here’s Barron’s and Barron’s telling us definitively to buy bonds and Bloomberg telling us with a little less conviction.

The most interesting point to me from the Bloomberg piece was the idea that bonds can still offer useful diversification benefits “as long as correlations don’t get too close to 1.” The piece said that twice.

I don’t assume any sort of concerted effort here, just a building consensus, it’s already been built really, that right here is a good level to add duration now that you’re getting a decent yield to wait. OK, except it was the same consensus that was publicly willing to buy duration at 2% and less and then got caught wrong footed, horribly wrong footed, last year. Now they are saying to buy here. Hard pass from me.

In the spring I had a very casual conversation with another advisor who was kicking the tires about having me sub advise his client accounts (I would manage the portfolios). It didn’t happen which is probably for the better, but I was struck by one comment he made. He was very worried that I would sell his clients’ bonds which were (and still are of course) very under water. Selling bonds down 30% or whatever would result in a permanent impairment to capital. These bonds are going to sit underwater for the next 12, 13, 15 years paying 2% like the UVA 100-year bonds paying 3.23% for 96 more years.

It is difficult for me to believe that these bond buyers at sub 2% and now here have great understandings of risk. I won’t claim a great understanding but will say I’ve put in the effort to try to understand risk better.

Here is an interesting quote from the first Barron’s article. “The 30-year Treasuries would gain nearly 13% over 12 months with a 0.5-point drop in yields, based on current levels, but the bonds would lose less than 3%, including interest, if rates rose by a half-point.” Yeah, that sounds pretty good (giving them the benefit of the doubt about the math)… pretty good for an equity. Not great for an equity but pretty good. And that has been my point. Duration stopped being a one way trade almost two years ago. It now offers equity beta, increased correlation and what I have been calling unreliable volatility.

For now, the yield with very short duration, which avoids the price risk and volatility I’m talking about, is higher than what you get from duration. Yes there is reinvestment risk, no question. I recently rolled a T-bill for clients buying in at 5.3% or so for one year. Next fall, the yield could be less than what it is now. As opposed to all the reasons listed in the above linked articles about why longer duration yields will go down, I see very few people, maybe no one talking about the yield curve normalizing with some sort of bull steepening where the front end of the curve goes down in yield and the middle and further out stays in the same area it is now. With the curve flat or inverted, I do not think it makes sense to take on duration, ongoing theme here for a long time. Bond markets are dynamic of course and at some point it will make sense to go into that part of the curve but not here, not yet, not for me. 

Back home on Sunday to close out this post, there was a medical emergency on our flight from Honolulu back to Phoenix. I spent about an hour or maybe a little longer working on the patient with a nurse who was also on board as a passenger. Shockingly, this is the second time I've done this. I fly, maybe a couple of times per year, so two in a lifetime seems oddly high. Anyone here work in the airline industry to weigh in, please do.