In baseball, a "fat pitch" occurs when the pitcher makes a mistake, and the ball appears to the hitter as being so fat there is no way he can miss it. In the realm of investing, a fat pitch opportunity occurs when market emotions have become so extreme that an asset class is totally mispriced and presents almost a no-miss scenario for the investor willing to step up to the plate.
I believe we have several of these opportunities facing us today and they are worthy of your review and consideration. While the recent market correction has created tremendous opportunity in stocks of high quality companies, today I will focus on other market segments
Normally, municipal bonds issued by city, county or state governments provide a lower yield than comparable U.S. Treasury bonds due to their tax-free status. Presently, 10 to 30 year U.S. T-bonds yield about 4 percent +/-. You can earn close to 5 percent tax-free in a portfolio of medium and high quality municipal bonds. This is the equivalent of earning 6 to 7 percent in taxable bonds.
Selling by hedge funds has forced prices lower and yields up, creating an opportunity for investors to lock in tax-free rates, which are very favorable compared to treasury bonds of equivalent maturities. A good quality mutual fund can provide instant diversification across many issues, minimizing the risk of having too much in any one bond. While defaults are rare in good quality municipals, there is still a risk which is minimized by diversification.
Corporate bonds are classified in two basic groups. High quality bonds, those rated A, AA or AAA by rating agencies, are issued by companies with a very stable financial status, and the bonds may well be secured by assets of the corporation. These higher quality bonds tend to pay yields a small amount, usually 1 to 2 percent, above the rate offered by U.S. T-bonds to compensate for the fact that no corporation can be as secure as the government of the U.S.
High yield corporate bonds are issued by companies with lower credit ratings, and investors demand additional compensation, in the form of higher interest yield, to purchase these riskier bonds. Typically, the spread in interest rates for high yield bonds is 4 to 6 percent above the U.S Treasury bond yield.
Today’s credit crisis has spread fear of default to the point where high quality corporate bonds are yielding about 5 percent more than T-Bonds, and high yield corporate bonds are at an astounding 15 percent spread over Treasury’s. Even if you assume default rates double or triple the norm, or even as bad as the defaults observed during the Great Depression (not likely in my opinion), you would still earn a higher total return over the next several years by owning both high quality and high yield corporate bonds, compared to buying a 10-year Treasury bond yielding about 3.8 percent.
Perhaps even more so than with municipal bonds, I believe corporate bonds are best owned through a fund or exchange traded fund structure to gain the benefit of diversification, professional management and analysis of the credit quality of the issuing corporations.
Fat pitch investment concepts are not an exact timing method, nor do they imply zero risk. They are concepts which we believe the odds of success are stacked in your favor as the emotion of fear causes prices to be driven downward in an unjustifiable fashion.
Tom Breiter is President of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.