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FIXED INCOME ACCOUNTS                        

"Capital is to a money manager as plant and equipment
 to a manufacturer.  If there's a fire at the factory,
 you want to have something set aside in order to rebuild."

Every portfolio should, in my opinion, have two components:  a risk allocation, and a certain amount of "safe money."

For the portion of your account that must remain secure, or for the investor seeking steady cash flow from his or her assets, and a minimum of exposure to the vagaries of the market, we offer a managed bond account.

These Fixed Income accounts contain primarily investment-grade bonds of varying maturities.  Often, depending upon the client's risk tolerance, a portion of the account may be directed to convertible securities; common shares of utility companies; publicly traded partnerships; preferred stocks; and below-investment grade bonds.  The decision to include these types of securities is made in conference between you, the client, and James Pappas as the manager.

Bonds are selected based upon credit quality, maturity, call provisions, and relative value given the conditions prevailing in the market.  Historically we have "laddered" maturities, that is, we arrange the portfolio so that bonds are maturing or being called on a regular basis.  This eliminates the necessity of making a guess as to the direction of rates. 

Still, there are times when you must make assumptions about the direction of rates and markets.  This is such a time.

Our now long-held feeling that rates should rise has proven not to be an immediate threat:  rates remain (in our opinion) abnormally low.  Still, we have the strong opinion that rates should go up over the next few years.  This has changed our approach.

If rates do go up, bond prices will come down.  To protect our accounts in a rising rate environment, we have lately emphasized bonds of shorter maturity, from one to a maximum of ten years.  This is considered an intermediate maturity level in a market in which the benchmark is thirty years.  Shorter-dated securities should decline less than longer-dated securities in a rising rate scenario.

Buying shorter maturity bonds gives us yields that are lower than what may be available with longer paper, but that is the trade-off for protecting your capital should rates rise.  Protection of principal is always uppermost in my mind.  

There may, of course, be issues of longer maturities that we find attractive enough to buy, but your average maturity will still be in the 6 to 8 year range.  That is a level that I am comfortable with right now.  

In years past I have actively and extensively invested in convertible bonds.  Lately, though, there have been very few convertible bonds that have appealed to me, and my allocation to convertibles has diminished sharply versus my historic levels.  I hope that in the future this market will once again become a larger part of my strategy, but that is not likely in the near future.

While I often buy bonds that I believe will be called, you must know that there is no guarantee that any given bond will be called.  You should further know that bonds are readily salable, but that the price available will be dependent upon market conditions, and may well be lower than your cost.

It is my style to be a buyer of bonds and never a seller.  That is, I buy and hold until call or maturity. 

The goal is to produce steady cash flow, while avoiding exposure to the fluctuations of the stock market.  It is important, however, to remember that, as mentioned above, bonds do indeed fluctuate, sometimes dramatically.  While this means that your monthly statement may reflect an increase or decrease in principal, it is equally important to know that, with bonds, at a certain point in the future you will receive at least par value for your holdings.  I suggest to bond buyers that they ignore fluctuations in market value and instead concentrate on the yield of their holdings.



Here is how to read bond descriptions,  using this example from December 1999 (those were the days!):

BellSouth Telecom 7 7/8s'32 at 98 1/2 callable Aug. '02 at 104.29 (AA-)
>The name of the issuer is, of course, BellSouth Telecom
>7 7/8 is the coupon (expressed as a percent)--multiply par value ($1000) by this percentage to find your annual income per bond, here $78.75
>s'32 indicates that the bond matures  in the year 2032 (the "s" separates the coupon from the year of maturity)
>98 1/2 is the bond's price, expressed as a percentage of $1000--in this example $985 per bond
>callable Aug. '02 at 104.29 means that on August 1, 2002, the company has the option of  paying you $1042.90 per bond to retire  the issue
>(AA-) is the Standard & Poor's rating, with AAA being the highest and BBB- being the lowest investment-grade ratings.  Ratings of BB+ and lower are called "junk bonds".

In this example, you would receive your coupon interest of $78.75 per annum for each bond held, which equates to a current (annual) yield, based upon a cost of $985 per bond, of slightly more than 7.99%.  (Divide $78.75 income by $985 cost to arrive at this figure.)    Should the company "call" the bond in August of 2002, they would pay you $1042.90 per bond, resulting in a capital gain of $57.90 per bond.  The happy result is that you reap an additional gain on your invested capital.  Divide that premium by your holding period and add the result to your current yield to arrive at an approximate "total return".



There are several calculations of yield, including current yield, yield to maturity, yield to call and yield to worst.  Other factors to be considered include sinking fund provisions, holders redemption options, fixed charge coverage, credit ratings and credit watch direction.  Please educate yourself before buying any security.


James Pappas and James Pappas Investment Counsel LLC makes no recommendation as to the suitability of these securities for your account.  You should not infer that a listing above implies a recommendation of any kind.  The securities listed are shown for purposes of illustration only.

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