This is an educational article regarding the process of finding and selecting under-priced fixed-income securities that trade on the stock exchange.
It argues for using relative valuation when making a buy recommendation on a particular fixed-income security.
BofI Holding’s 6.25% Subordinated Notes maturing on 2/28/2026 are used as a case study in using relative valuation to find a very undervalued fixed-income security.
In the world of fixed-income investing, there is no objective value, only relative value. There is no interest rate (yield) that one can say is right for a particular security. For example, preferred stocks currently sell at yields that aren’t much different from yields that existed when the 10-Year Treasury yield was half of what it is now. So are preferred stocks overpriced now or were they underpriced when the 10-Year Treasury had a significantly lower yield?
My major gripe regarding some Seeking Alpha authors who promote fixed-income ideas (preferred stocks or bonds) is that they use an objective valuation approach rather than a relative valuation approach in their security selection process. They provide information about the company that issued the fixed-income security that they are promoting, and about the details of the fixed-income security that they write about (yield, price, call date), and expect that is enough to make an investment decision. However, no evidence is provided that their recommended security is a relatively better value than other similar securities issued by other similar companies. Sometimes I find the recommendations to be relatively overpriced and inferior.
Tips For Finding and Selecting Undervalued Fixed-Income Securities
1) One of the lessons I have learned from my 20 years of trading fixed-income securities is that the best values are in unrated fixed-income securities. You can generally get preferred stock and baby bond safety ratings from Moody’s and S&P from QuantumOnline.com, but when checking safety ratings at QuantumOnline, you will discover that a large number of fixed-income securities are not rated. This only means that the company has decided not to pay the rating agencies to rate their fixed-income securities. But many unrated securities are extremely safe. Despite this fact, many mutual funds and other institutional investors have instructions not to buy unrated securities. Therefore, unrated securities are often underpriced due to lack of buying from “big money” and the fact that they are avoided by those who do not want to take the time (or have the knowledge) to examine the safety of the company themselves. In my opinion, it is well worth taking the time to look into unrated securities as you will greatly outperform the benchmarks by finding the unrated gems. Learning the basics of reading a balance sheet will go a long way in becoming a successful fixed-income investor.