Are You Investing In Bonds?

Lately, we’ve been thinking about Carl Icahn’s warning about a possible junk bond crisis.

Lehmann Livian Fridson Advisors Chief Investment Officer Marty Fridson also recently said the bear market in high-yield bonds could get ugly.

So what’s an average investor to do in this type of situation…?

Don’t worry. We already asked the experts for you.

Should YOU trade bonds?

Trading bonds sure is different and a bit more confusing than equity trading.

Flammarion Capital Bonds Trader and Head of Automated Strategy and Development Ezra Rapoport explained that the bond market is intricate.

“Everything from the way bonds are priced to settle procedures for the futures - it's all highly idiosyncratic so really you have to have been trained in those markets by someone who's been doing it for a long time,” he said.

The bond market has been bullish for probably the longest time ever. Rapoport speculated that many people have likely gained from having bonds in their portfolio without even realizing it.

The certainty of the bull market, however, is no longer there.

“Oppenheimer - they're the biggest Puerto Rico bond holder right now because of mutual funds, etc.. and conservative investors were steered towards those bonds because of their tax advantage status and it was traditionally considered risk free,” Rapoport said. “Now, they're selling it less than 50 cents on the dollar for those assets. Bonds are more nuanced than the last 3/4 century or even longer have lead people to believe.”

Rapoport warned of reinvestment risk – when you get your return and principal back on a bond and want to reinvest it to continue earning the return, but the yields are lower – as well as the risk of the value of the bond depreciating while you hold it.

The Steady Trader Head Trader & Investment Strategist Serge Berger used to trade high-yield bonds at JP Morgan. He told us he believes the struggle in trading bonds stems from the lack of readily available information.

“I don't think people should trade bonds because the information flow isn't really there. You basically need to have access to either a special newswire where you plug into all the fixed- income news flow,” Berger said. “So, it’s a much more special institutional market -- like you almost need access to one of the big investment trading desks because you need to understand when the new issue is coming out.”

Berger also noted that it requires much more macro understanding to trade bonds than to trade equities. He has noticed some nice moves, however, in ETFs like iShares iBoxx $ High Yid Corp Bond ETF (NYSE: HYG) and SPDR Barclays Capital High Yield Bnd ETF (NYSE: JNK) which have had a few 5% rallies in the recent months.

Is a Crash Inevitable?

Rapoport told us that while predicting how serious the crash could be is difficult, Icahn’s concerns are not without basis.

“Everyone is looking for sectors that yield and there's always one, obviously the high-yield sector, where you can get returns. So basically, what a lot of people see is a disproportionate piling into the high yield sector as people reach for yields that they're not getting from safer assets,” Rapoport said. “It's very easy to see a dynamic whereby as rates go up people come rushing out of high-yield sector and that dynamic is definitely plausible.”

But remember that Berger said: Even without the potential risk of a crash, investors might want to be wary of entering the high-yield market.

For the average investor, he suggests 5 or 10 year bonds for retirement portfolios.