Why you and I are better at rating bonds than Fitch

Whether you're a business owner looking to save taxes or you're looking for ways to boost retirement income, muni bonds are offering excellent yields these days, but the bond rating companies have lost a lot of credibility in my opinion so you have to be smarter about what you buy.

When a prospective client this week asked me which rating company I have the most confidence in, I replied "me!"  It's not that I claim to be smarter than the analysts or that I have more information, but when researching any investment you have to be willing to dig into the details and ask some common sense questions, and you can't simply rely on how the ratings companies rate a bond.  Since I represent my clients as a fiduciary and I'm not a salesperson, I take a common-sense approach to researching and selecting the bonds for my clients' portfolios.  Common sense sometimes takes a backseat on Wall Street, bowing to their "demi-gods of higher math" but where I come from, common sense prevails over confusing gobbledygook.  Even the least investment-savvy clients ask great common sense questions which help guide buying decisions in a portfolio.

I don't completely ignore bond ratings, but they created their own mess.  Companies like Fitch and S&P have taken a rap during this financial crisis for mis-rating packages of sub-prime residential loans, known as collateralized debt obligations (CDO's).  Though these loans were high-risk, the ratings companies apparently thought if a broker packaged a bunch of them together, the chances of all of them defaulting were slim, so they rated them as "investment grade." Now common sense would dictate that "investment grade" means "high-quality,"  and to me and my investors, that's what we expect from investment grade bonds.  That's why you have to look beyond bond ratings.

I look at the municipality's source of revenues to pay the bonds, how well established the community is (versus an area that has relied on big future population growth from new housing) and a host of other factors when I'm buying muni bonds.  General obligation bonds are paid from tax revenues, and the state or municipality can raise taxes to pay for those bonds, but I always think twice about a state with serious budget problems.  Revenue bonds are paid from assessments, whether they are sewerage fees paid by homeowners or highway tolls collected from drivers, but you have to ask questions about the viability to collect those revenues.  Nobody has a crystal ball into the future, but oftentimes common sense questions can help you avoid buying bad bonds.  I can't use a blog to provide specific investment advice, so if you're interested in discussing this topic further, give me a call or send me an email message.