September 14, 2008: Spreads Encourage High-Yield Risk

Most readers of my almost daily blog are aware that I have been searching for securities that promote a high yield without assumption of even higher risk. Until recently, the risk/reward basis for these issues, especially financials, was not worth the yield stretch. I admit to being early on several financial securities and paid the price. Investors know that the best time to buy distressed high-yielding instruments is when yields are going down, which indicates that the worst is over. I admit that this is not yet the case, but better to be prepared to strike when things improve rather than play catch-up to the cycle.

With the drumbeat of companies going belly-up, the spreads are now wide enough between high and not-so-high quality issues to warrant some investigative research leading to speculation. The strength of the dollar has also opened up opportunities to invest in blended worldwide higher-yield funds that are managed rather than indexed.

One fund I like now that the Fannie Mae and Freddie Mac situation is close to becoming resolved is the Fidelity Strategic Income Fund (FSICX). FSICX has been around over ten years and has a decent track record with the current portfolio of over $5.4b well-positioned to lurch forward with both good income and modest capital gain returns. I especially like the fact that only 4.5% of the portfolio is in the financial sector. Match that against other worldwide income funds. Granted, about 12%of their holdings are rated junk, but FSICX does maintain about 39% in government and AAA corporate securities. Nice blend for the aggressive income investor. 15% of their government holdings are in Fannie Mae and Freddie Mac bonds, which should be whole by the time Uncle Sam bails the bums out of hock. Expenses are higher than ETFs, presently at .74%. I believe it is worthwhile to have these type of funds managed given the current environment and will pay up for active management at this juncture. FSICX's 30-day annualized yield is 5.74%.

If you are considering individual issues, I strongly recommend you stick with short maturities and companies that have a track record of digging themselves out of holes. Examples of these would include:

Sealy Mattress 2014 yielding about 12.50% with EBITA of 4.1
MGM Mirage 2014 yielding about 10.30% with EBITA of 5.7
Dole Food 2010 yielding about 11.40% with EBITA of 6.7
Unisys 2012 yielding about 11.80% with EBITA of 1.7
Royal Carribean 2016 yielding about 9.90% with EBITA of 4.4
Beazer Homes 2011 yielding about 18.00% with EBITA of 17.8

If a bailout or financial package comes the way of the big three automakers, I would take a look at the ultimate roach hotel security, GMAC SmartNotes. Priced in $1000.00increments, they are all over the map in yield. Many are very difficult to sell at any price because they are not secured, so you had better plan to hold them until maturity. With so many customers (GM employees, retirees and small investors) holding SmartNotes in pension accounts, I think General Motors and Cerebus of GMAC Capital would be reluctant to leave these folks holding the bag. If you believe that notes will be redemmed at maturity, take a strong look at those due to mature from 2009-2011. The investor willing to dig through the mass of SmartNotes may be rewarded with individual issues that are mispriced vs. other SmartNotes, thus presenting a potential excellent highly speculative opportunity. These are not for money you hold precious to your financial and mental health.