Today I made my first post-quarantine-investment in the financial markets, and I will tell you exactly why and how I did it.

If you read last week article on crisis investing you may already guessed where I decided to put my money.

As you know, we are in a time of great uncertainty about our economy and our respective countries, we don’t know the duration or the depth of the current crisis. Therefore I decided to stay safe and not invest in stocks (yet).

Where did I put my money then? I decided to buy bonds and, in particular, high-yield bonds.

Summary:

  • Context
  • What are bonds and high-yield bonds?
  • My investment in high-yield bonds

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Context

We are in a time of great uncertainty: the depth and duration of the economic impact of the coronavirus are unknown. While the stock and bond markets recovered from their biggest drawdown since the 2008 financial crisis, there exist a possibility of another drawdown. A critical question remains unanswered: have we touched the bottom yet?

From history we know that the whole drawdown can take months (if no years) with multiple rebounds. It is almost impossible to time our entry to the stock markets, and even experts are in disagreement on whether we passed the bottom or not. Even if buying the bottom would lead to enormous returns, it won’t be the strategy of this newsletter.

My opinion is another drawdown will occur before the end of the year. But I may be wrong.

In “normal” times it is extremely difficult to beat the index. Times of crisis are also times of great opportunity. During times of crisis it can be easier to reach good returns. If you keep calm and make good decisions.

For our first investment I see four options:

  • Treasury bonds. The usual go to investment during crisis is treasury bonds, because they are uncorrelated to stocks. Stocks and treasury bonds have been negatively correlated since the 2008 financial crisis. However a big mistake we could make is to assume Treasuries will always be negatively correlated with stocks. In a highly inflationary environment, both stocks and Treasuries will perform poorly and become positively correlated.
  • IT stocks. The current context is special because we see that some stocks are (negatively) affected more than others, in particular IT stocks are the one performing quite well.
  • Small value stocks. We covered them last week, they tend to outperform the market after the bottom is touched.

So that is three options, what is the fourth? :)

As a first investment I preferred to stay cautious and consider another option that has proven to be effective in past crisis: high-yield bonds. We saw last week that they tend to outperform the market in time of crisis.

What are high-yield bonds?

High-yield bonds (also called junk bonds) have lower credit ratings than investment-grade bonds and therefore pay higher interest rates. Typical issuers of high-yield debt are startup companies and capital-intensive firms with high debt ratios.

High-yield bonds are more likely to default, so they pay a higher yield than investment-grade bonds to compensate investors for the risk taken. This higher yield usually don’t really cope with the default rate. Except in times of crisis: credit valuation is often a tractable problem even in times of great uncertainty.

Bonds are graded by credit rating agencies and assigned a bond credit rating. It represents the credit worthiness of corporate or government bonds (the likelihood the debt will be repaid). High-yield bonds generally refers to B (B1, B2, B3) and CCC (CCC1, CCC2, CCC3) . The figure below shows expected yield and return by investment grades:

My investment in high-yield bonds

Once I decided I wanted to invest in high-yield bonds I had to figure out how to do it.

In times of crisis we want to reach for yields in the B and CCC ranges. In these ranges the average return is high however the standard deviation (because of the default rates) is also high. Therefore we want to diversify and invest in many bonds to prevent our performance to be cut in half because of some unlucky defaults. The easiest way to diversify is to invest in ETFs: they take care of the diversification for us, and we just have to hold one line in our portfolio.

Bonds are less popular of an investment than stocks or commodities so it can be tricky to find good entities. However I found two ETFs (Exchange-trader funds) on eToro: iShares iBoxx $ High Yield Corporate Bond (HYG) and SPDR Bloomberg Barclays High Yield Bond (JNK).

These ETFs are good choices because they mainly focus on BB, B and CCC grades. They provide a 5.2-5.9% yield (that I expect to go up in the next months) and enough liquidity.

Keep in mind that when investing in high-yield bonds we are not speculating on the price (which more or less stays constant) but on the yield (i.e. interests). They should be credited on your account every month.

I decided to split my investment and invest between both: $100 in each.

Next week I will present some tools that I use to invest, for now my whole portfolio is on eToro. You can join using my affiliate link and find me under @kprimice: follow me in order to be notified about my next moves, or even automatically copy my portfolio (Spoiler alert: I already made 2 other investments on eToro I will write about soon).

If you prefer to invest manually you will find the two ETFs under these links: JNK and HYG.


That’s all for today!

Also, if you have any question or feedback: leave a comment :)

See you next week!

Kevin from Hook


Further readings and useful links:


This newsletter does not provide investment advice
As always, trading activity is risky and exposes you to loss of capital. Never invest more than you can afford to lose. Never. The information presented on this page (and every other) are not investments counsels. Your use of this content is at your own risk. The content is provided “as is” and without warranty of any kind, either expressed or implied. All views and opinions expressed here are the author’s own, and are not representative of the views of any current, past or future employer.