The world’s smartest investors don’t lose sleep during a crisis.
That’s because they are prepared. They take advantage of a sophisticated type of investment that most investors know nothing about. And they use it to make loads of money when everyone else is selling.
It’s a rare type of corporate bond we call a “penny bond”…
These bonds are different from the bonds in your 401(k). They have nothing to do with “bond” mutual funds… U.S. Treasury bonds… or bonds issued by blue-chip companies like Apple (AAPL), which are little more than a way to park money and earn 2% interest.
Buying the right penny bond is the opposite… It’s one of the safest strategies you’ll find anywhere in the markets.
Today, I’ll explain how this strategy works – and why a major crisis on the horizon is handing us the perfect opportunity to start using it…
First, let’s start with the basics about corporate bonds…
Corporate bonds are debt instruments issued to the public.
They’re typically issued in increments of $1,000, known as the “par value” or “principal” of the bond.
Unlike a share of stock, a bond is a legal contract between the issuer (company) and buyer of the bond. That makes bonds much safer than stocks. The buyer is legally entitled to collect the full $1,000 par value on the bond’s stated maturity date, regardless of what he paid for the bond.
Along the way, the buyer is also entitled to receive regular interest payments (usually every six months) for lending the money.
That’s how most bonds work. And most bonds are pretty ordinary investments… They yield between 2% and 5%, on average, per year – almost exclusively from the interest.
Now, bonds are much easier to analyze than stocks. That’s because they’re binary.
With corporate bonds, you only have two possible outcomes: The company either pays you what it owes you, or it doesn’t. That’s it… You can completely ignore daily fluctuations in the price of the bond after you’ve bought it.
If the company pays you all of your interest and principal, you know exactly what return you’ll make on your investment at the time you buy the bond. And if the company doesn’t pay, it’s considered to be in “default” on its debt and lenders can force it into bankruptcy.
So when buying a corporate bond, the only question is: Will the company stay in business and pay you all of your interest and principal through maturity?
It’s really that simple.
As bond investors, we only care whether a company can pay our interest and principal. That’s all that matters. So in our Stansberry’s Credit Opportunities newsletter, we always analyze two factors to determine if a company can pay us…
- Whether the company can afford the annual interest costs on all of its debt (not just our bond), and
- Whether it will have enough cash on hand to pay off our bond at maturity.
The first question is the most important… If the company can’t afford to pay the interest on all of its debt, its lenders can force the company into bankruptcy.
We’ll never recommend a bond from a company that we believe will go bankrupt.
So to make sure the company can afford its interest payments, we use one key metric – the “interest-coverage ratio.”
That’s how many times the company’s earnings before interest cover its interest costs. (We use “cash profits” to measure earnings. Cash profits are the cash that a company makes from its core operations. The metric can be found in a company’s statement of cash flows under the “net cash provided by operating activities” line.) We like to see interest-coverage ratios of at least two times.
The second question tells us how the company will pay us our principal when it’s due. If we project that the company won’t have enough cash in the bank at maturity to pay our recommended bond, we know it will need to refinance its debt with other loans to pay us.
That’s OK… We don’t care how we get paid, as long as the company does it.
We can use these same questions to analyze any type of corporate bond – including the rare type of bond we call penny bonds.
Penny bonds are different from most corporate bonds in one critical way…
They trade for a fraction of their contractual par value – at discounts of 10% to sometimes more than 70% from par value.
The companies that issue penny bonds have the same obligation to pay you $1,000 at maturity, even though you only pay a fraction of the usual $1,000 cost. That enables you to earn large, stock-like capital gains with a much safer investment than stocks. Plus, you collect interest payments that can be up to 20% per year on the amount you invested.
Most people don’t know that it’s possible to buy this type of bond as an individual investor…
The key to success with this type of investment is knowing which bonds will pay you, and which ones won’t. If you can find penny bonds that you know will be paid in full at maturity, you can make massive returns with far less risk than investing in the stock market.
But finding truly great, safe penny bonds with extraordinary returns is only possible in rare moments of crisis… like the one we’re about to enter.
As I told DailyWealth readers recently, the corporate-debt market is facing a “wall of maturities,” starting this year and ramping up into 2021 and 2022. Spurred on by low interest rates, companies have borrowed heaps of money – more than $12 trillion over the past decade. Now, a record $4 trillion must be paid or refinanced over the next five years… And we will see a huge panic as this massive wall of debt comes due.
The coming crisis will make it possible to buy high-quality bonds for $0.60… $0.50… even as little as $0.30 on the dollar. That’s partially because of investors’ herd-like mentality…
Just like stocks, bonds trade in a public market that is heavily influenced by emotions and liquidity. When enough investors become fearful, panic sets in… And everyone starts to sell.
But there’s another major reason the bond market reacts violently in times of a crisis…
You see, most corporate bonds are not held by individual investors. Instead, they’re held by big institutions like mutual funds, pension funds, and insurance companies. These institutions have policies that require their holdings to be rated “investment grade.”
Credit-ratings agencies assign a rating to most bonds, depending on how safe they believe the bonds to be. Ratings range from “AAA” (safest) all the way down to “CCC” (riskiest).
The lowest rung on the “investment grade” ladder is “BBB.” When a corporate bond with a “BBB” rating gets downgraded, it’s moved into “noninvestment grade” or “junk” status (“BB” or lower). When that happens, big institutional investors are forced to sell their positions.
This is important because roughly half of all investment-grade bonds today are rated “BBB.” That number has quadrupled over the past decade. And as interest rates rise and the wall of maturities unfolds in the coming years, we believe many of these bonds will be downgraded to junk status.
That means we’re going to have plenty of attractive opportunities to scoop up safe penny bonds…
Thousands of portfolio managers will be forced to sell their safe bonds solely because they’ve been downgraded by the credit agencies. And since the bond market is much less liquid than the stock market, the number of buyers won’t be enough to absorb the increased supply. Massive selling will force prices much, much lower… And these safe bonds will trade for pennies on the dollar.
We saw this new crisis approaching three years ago…
That’s why we launched Stansberry’s Credit Opportunities in November 2015. Since then, we’ve recommended 24 penny bonds and closed 16 positions with an 88% win rate. Remember, these recommendations all have legal protections that no stock can ever offer.
Meanwhile, the average annualized return of our closed positions is 29%. That’s almost 50% more than the return of the stock market… The benchmark S&P 500 Index’s weighted return during the same period is 20%. And beyond that, it’s three times better than the return of the overall “junk” bond market’s return of nearly 10% in the same stretch.
Keep in mind… we’ve booked these impressive gains before any panic has set in.
That means the biggest opportunities are still ahead of us.
Good investing,
Mike DiBiase
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Source: Daily Wealth