Gorging on Apples

I’m attending a Fidelity Investment conference in Florida and working to open our new Naples office. Farr, Miller & Washington Bond Manager, Andy Mathes has written this weeks “Market Commentary.” I hope you find it helpful.


The appetite of the fixed income investor is voracious. Apple was the course of the day with the largest issuance of corporate bonds in the history of our republic – $17 billion. The Silicon Valley behemoth served up a smorgasbord of floating and fixed rate debt with maturities ranging from 36 months to 30 years. While Apple is highly rated (AA+ by S&P), the deals’ lead managers, Goldman Sachs and Deutsche Bank, found insatiable buyers willing to gobble up the debt at impressively low yields of 0.51% for the three year maturities and 3.883% for obligations due in 2043.

The Treasury bond market currently implies 2.33% inflation over the next ten years. Apple borrowed for ten years at 2.41%. This suggests that investors in Apple bonds are accepting a real return of 0.08% per year. And the owner of the Apple note will pay taxes on their receipts, unless the paper is held in a tax exempt account (IRA).

Last week the country of Rwanda sold ten year “junk” bonds at a yield of 6.875%. The metric for judging just how attractive a bond looks can now be gauged by comparing the book ends of Apple on the quality side and, “Whoa, why would they have to pay more than Rwanda?” on the other. The tendency for clients to stretch for yield (by extending the term or reducing credit quality) can be exceedingly dangerous, and we advise resisting these temptations.

Farr, Miller & Washington seeks to defensively maximize returns in the current low yield environment. We generally keep the average maturities of portfolios short (inside of 5 years) with an emphasis on credit quality. The vast majority of our purchases are of amounts under $100,000, known as “odd-lots”. The reduced demand for smaller blocks results in attractive yields, at least on a relative basis. An additional way in which we seek to add value for fixed income accounts is through the purchase of bonds that are currently callable. We purposefully seek out bonds coming due within a limited time horizon and subject to calls that we believe will not be exercised – the end result is a security that has a short time to maturity, combined with an attractive yield.

The adage “pigs get fat, and hogs get slaughtered” seems more than appropriate here. When it comes to building a fixed income portfolio, diligence and persistence find their just rewards. Keeping our duration short will allow us to benefit from the opportunities that will present themselves in the near future. And we’re optimistic about the future.