You've got a couple of thousand bucks to invest, maybe only a thousand, and you want to keep pace with those miserable inflation figures (currently running at more than a 13 percent annual rate). You look like a sure loser if you put your money into bank savings or bank certificates, corporate bonds, Treasury bills or those hot daily income trusts (which focus on short-term money market instruments yielding roughly 10 percent). None even comes close to 13 percent. There's always the stock market, of course, and maybe Las Vegas, but they're rife with risk. So how do you cope?
I put that perplexing question the other week to Gifford Fong, 34, the head of an investment consulting firm bearing his name in Santa Monica, Calif. Fong (which means foresight in Chinese) specializes in computer analyses of portfolios, with considerable emphasis on likely rates of return based on interest-rate expectations.
Fong doesn't deal with the public; his clients include the classiest names in the institutional investment world (the likes of Morgan Guaranty Trust, Citibank, the State of Connecticut and the First National Bank of Chicago). Still, he rate projections. For example, his most bullish case - generating those 20 percent to 21 percent returns over the next year - assume a drop in long-term interest rates of 100 basis points (or 1 percent) in the same 12-month period. Fong's most likely case is predicated on a projected interest-rate decline of 50 basis points, or 1/2 percent.
The worst case, which still provides estimated returns on the bonds of 11.2 percent of 11.6 percent, assumes a modest rate drop of just 15 basis points. Most economists, though, think the decline in long-term rates will beconsiderably larger than that.
There's always the danger, of course, that interest rates could go up, not down. And should this occur, bond prices of course would decline. Except for perhaps a minor blip on the upside, though, Fong believes the trend is clearly down.
You'll note that all 20 bonds picked by Fong are selling below par ($1,000). This discount has been amortized over the life of the bond, and therefore the current return, as reflected in yield to maturity, runs higher than the coupon. For example, in the case of Baltimore Gas & Electric, the bond sells at had an idea of how the little guy could cope with that agonizing inflation rate over the next year - recognizing, of course, that there are no guarantees. What struck me was the seemingly minimal amount of risk.
Fong's surprising choice: quality of risk.
Fong's surprising choice quality corporate bonds.
I thought at first he was kidding. When I think of quality corporate bonds, my mind is immediately attuned to a coupon (or annual yield) of about 8 percent to 9 1/2 percent.
Wrong, said Fong. "You're in one of those special points in time in an economic cycle when you've got the opportunity to make a lot of money in bonds," he told me.
Fong's theory is simple enough. You put your money into select long-term, high-quality corporate bonds on the premise that interest rates - currently at records levels - are likely to decline over the next year, the result of a recessionary climate in which there's decreasing demand for funds. Given such a scenario, bond prices would rise. Add another annual yield, ant it's Fong's contention that you can easily make a case for a probable return over the next 12 months of 14 percent to 15 percent. He also says there's a good shot at a heftier return in this period, possibly 20 percent to 21 percent.
It sounded intriguing. How does one go about investing in such bonds, I wondered? With that thought in mond, I asked Fong if he would create a portfolio of corporates that meet his criterion. He obliged, coming up with a selection of 20 favored securities (featured in the chart) from a computer screening of about 18,000 bonds.
His projected rates of return (as show) factor in different interest- $890.99 - a discount of $109.01. Accordingly, this has pushed the annual return to 9.5 percent from the coupon rate of 8.375 percent.
Traditionally, Fong tells me, deep-discount bonds - which are basically what he's picked - give you the best price appreciation (among money-market instruments) in a period of declining interest rates.
It should be pointed out that even deeper discounts are available in what are called junk bonds (corporates with lower credit ratings than the single-A to triple-As chosen by Fong). However, he thinks they should be avoided at this juncture. His reasoning: The expected rates of return should be lower in junk bonds because, in times of a recession, bond buyers go for quality, not question marks.
Fong, by the way, is not strictly a bond man. In addition to running a computer analysis service, he manages some $13 million of investment assets which include both fixed instruments and equities. And Fong tells me he's looking for a good stock market over the next year, with total returns (price appreciation, plus dividends) on the oerder of about 15 percent. Considering that the associated dangers are much greater in stocks, he thinks bonds are clearly a superior choice for the little guy.
With the kind of juicy returns he's talking about, though, those bonds he's picked could be a superior choice for the big guys as well.
After all, who in this treacherous market environment - big guy or small guy - is about to snub his nose at a 20 percent to 21 percent return on his money with a seemingly minimal amount of danger?