Gyroscopic Investing

One thing that's been bothering me about LTT's is the tax-preference of their state taxability.  Yes, that's right... because to a lesser degree, their interest rates are being arbitraged, much like Muni's.  This doesn't help me when LTT's are the #1 candidate for my tax-deferred accounts.  

For instance, if the going interest rate for a corporate bond is 5%, it would yeild the same as a treasury bond at 4.75% assuming a 5% state tax rate (pretty average).  So if we can assume that currently about a .25% tax arbitrage built into their spread, one wonders if they're getting a parasitic effect of this interest so often being paid in a taxable market, and pricing the yields naturally lower.

This may seem like blasphemy to some (as it does to me for now, until I investigate further), but depending on actual historical/current spreads (I can't find good yield spread info out there based on different classes of bonds), would owning some AAA corporate bonds in our tax-deferred accounts be a good idea to juice returns a bit?  Very important to me is how did this class of bonds perform in 2008?  Since AAA corporates made up a very small portion of the corporate bonds in Craig's LT bond graph showing how poorly corporates performed in 2008, I'm curious as to how AAA LT's alone performed.

I'm really against tweaking the LT bond portion, but I feel like I'm getting tax-arbitraged out of some return.  I know full well I'll get some friendly lambasting for tweaking the PP into a different bond form, but I'm just curious if we have some observational trends on this matter.

I would only use Corporates if you have moral objections to owning US Govt. debt. They won't offer the same protection as US Treasury bonds for US investors.

There is call risk with many corporate bonds, as well as widening yield spreads in a panic, as we saw in 2008.

In 2008, corporate yields rose, they didn't fall.

Even AAA corporates, MT?  I guess ratings would mean more to me if the agencies had any clue what they were talking about.  Call risk is huge to me (avoiding it).  I thought those bonds were by far the exception, not the rule.

I heard that the debt of the company that I work for was in very high demand during 2008, although I think he was referring to commercial paper, not necessarily long term bonds.  But I imagine that the demand for those went up as well.

Go on Yahoo Finance and do a five year comparison of VWESX (Vanguard long term corporate bond fund) and VUSTX (Vanguard long term treasury fund) and see which you would rather have had in 2008.

I'm just using VUSTX for convenience; 30 year treasuries did even better in 2008.

MediumTex wrote: Go on Yahoo Finance and do a five year comparison of VWESX (Vanguard long term corporate bond fund) and VUSTX (Vanguard long term treasury fund) and see which you would rather have had in 2008.

I'm just using VUSTX for convenience; 30 year treasuries did even better in 2008.

Exactly.  In any sort of panic or severe downturn, these two asset classes operate very differently.

moda0306 wrote:would owning some AAA corporate bonds in our tax-deferred accounts be a good idea to juice returns a bit?

Not unless you're a fan of credit risk.

AAA doesn't mean anything. In 2008, a AAA corporate rating turned out to be a joke. Rating agencies do a terrible job of estimating risk.

Keep in mind that the rating agencies are not only paid by the companies they rate, but they make their judgements based on the limited information provided by those corporations. It's a huge conflict of interest.

And, in fact, there is a paradox of a AAA rating that many investors never see coming:

...Structured transactions that involve the bundling of hundreds or thousands of similar (and similarly rated) securities tend to concentrate similar risk in such a way that even a slight change on a chance of default can have an enormous effect on the price of the bundled security. This means that even though a rating agency could be correct in its opinion that the chance of default of a structured product is very low, even a slight change in the market's perception of the risk of that product can have a disproportionate effect on the product's market price, with the result that an ostensibly AAA or Aaa-rated security can collapse in price even without there being any default (or significant chance of default).

Source: http://en.wikipedia.org/wiki/Credit_rating_agency

See also: http://en.wikipedia.org/wiki/Credit_rat ... #Criticism

Others have said this already, but no corporate or muni bond will have the "flight to safety" effect that LTTs are capable of.  This seems to me to be the reason Browned put them in the PP.  He looked a long time before he found an asset that performed well during a deflationary recession and LTT seems to be one of the only ones.

Yes... I've given up on this idea.  It'd be one thing if the rating agencies had some clout, but we all know where that's lead to.