'Junk bonds,' convertibles appeal to this pension pilot
Beverly Hills, Calif.
Investing in high-yielding bonds and convertible securities may not seem very glamorous in the middle of a roaring bull market. But for Howard S. Marks, who has his office in this glamorous part of Los Angeles, it's a strategy that works.Skip to next paragraph
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Mr. Marks, a vice-president of Citicorp Investment Management Inc., has devised a means of both riding the crest of the bull market and protecting his clients' assets during market declines by investing in what he terms high-yield, or lesser-quality, bonds and convertible securities.
High-yield bonds, which some people refer to as ''junk bonds,'' are the debt of lesser-rated companies. Convertible securities are mainly debt securities that can be converted into shares of common stock, based upon an agreed-upon formula. Sometimes companies issue convertible preferred stock, which is a form of equity. In buying these securities, Mr. Marks, who runs about $900 million in pension money, has outperformed most of the averages since Citicorp started offering the funds to its pension clients in 1978 and '79.
The $450 million of money invested in high-yield bonds has returned 13 percent on average for the three years 1980-82, compared with 11.5 percent for the Salomon Brothers Bond Index. And in the first quarter, his bond fund is up 9 .7 percent, compared with 3.7 percent for the Salomon average. At the same time, the $450 million invested in convertible securities has averaged a 19.2 percent annual gain between 1979 and '82, compared with 16 percent for the Standard & Poor's 500 and 13.5 percent for the Dow Jones industrial average.
Even more important, Mr. Marks has been able to protect the assets of the funds during bad years - a feat considered more difficult than making money during good years in the market. In 1981, when the Salomon Brothers bond index declined by 2.6 percent, his fund was up 7.7 percent. And that same year, the convertible fund gained 4.9 percent, while the S&P average dipped 4.9 percent. In part because of this better-than-average performance, the funds have grown rapidly from their initial funding of $20 million each.
The key to this performance is Mr. Marks's strategy. When he buys high-yield bonds, Marks looks for companies he calls ''emerging credits.'' These are ones just beginning to move up the corporate life cycle. And he also looks for ''renovated'' companies, which have just had a major change in management.
In searching for companies in the emerging-credit category, he looks for ones with an entrepreneurial spark - they have yet to mature and are still in a growth phase. First he subjects the companies to a cash-flow and credit analysis. Then, the money manager gauges how the companies ''feel'' before making his final investment decision.
Since the funds are fully invested all of the time, there is little speculation as to the future direction of interest rates. Rather, he notes, ''It's easier to predict the fortunes of companies'' than to predict the direction of interest rates.
In the high-yield portfolio he has included the bonds of hospital management companies, such as American Medical International and Charter Medical Company, and the casino operator Golden Nugget. He also likes the bonds of Integrated Resources, which syndicates tax shelters, and Lorimar, which produces television shows. Other favorites include Southmark Corporation, which is in the real estate business; Zayre Corporation, the retailer; and MCI Corporation, in telecommunications.
In buying convertible securities, Mr. Marks emphasizes that he is an investor in the securities, not a trader or arbitrageur. An arbitrageur is a trader who tries to take advantage of differences in prices between similar securities. Nor does he buy securities solely on the basis of the companies issuing them. In other words, he is not ''a stock picker.'' Rather, he looks for bargains in terms of pricing. ''I look for upside potential,'' he says, ''rather than downside risk.''
Naturally, when buying a convertible security he looks at absolute current yield, the annual cash return, the yield to maturity, which is the cash return plus any appreciation upon maturity, and the differences between the stock and bond yields. He specifically looks for convertible securities selling only slightly above the value of the stocks into which they can be converted.
In the bull market, these differences don't matter greatly, since the rising tide of stock prices floats convertible prices as well. For example, Mr. Marks purchased Lockheed's 41/ 4 percent convertible bonds at $810 per $1,000 bond. The stock at the time was $48 a share and the bonds were selling at a substantial premium to the conversion value. The bond recently sold as high as $ 1,980 per $1,000 bond, however, when the stock hit $116 a share. Mr. Marks took his profit, which came to 144 percent on the bonds. In addition, he received an extra 5 percent yield on the bonds.
He had a large, although less spectacular, gain with MCI's convertible bonds, making 34 percent in just over a year. Other big winners currently include the convertibles of Merrill Lynch, up 64 percent, International Paper, up 180 percent, Sensormatic, up 83 percent, Southwest Airlines, up about 47 percent, and Wal-Mart Stores, up nearly 10 percent.
In the high-yield portfolio, Mr. Marks owns Oppenheimer & Co. bonds, which ties its yield to the stock market volume. As the volume on the market rises, the yield increases. Recently Oppenheimer offered to buy back the bonds, which have a coupon of 18 percent, at $128 per $100 bond.
Not all of the issues are winners. An investment in MGF Oil Company has lost 44 percent of its value, and American Quasar Petroleum Company is down about 28 percent. But Mr. Marks points out that the price declines have been more than offset by interest earned. ''This shows the desirability of investing in convertibles,'' he concluded.