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Actively Trading Corporate Bonds

An anonymous reader recently left the following comment on The Bond Guide – Investment Guide to Corporate Bonds

Thanks for the great website and info on Canadian bonds. I’m a private investor, fed up with being wilfully kept in the dark about the genuine value of bonds.

From the link you provided to CBID I can now see my broker charges me something close to 2 basis points on bond purchases, which makes it very difficult to make capital gains when my bonds premium value goes up. I know you are probably not supposed to give advice but I was wondering what you think about private investors actively trading bonds (so buying investment grade at a discount and selling when the price goes premium)?

I ask because before reading all the great links you have provided I always thought of bonds as safe but rather boring as I believed one was always limited to the profit on the yields. I’ve noticed now that many bonds I have bought at discount are worth perhaps 7 or 8 basis points more now. I’m very tempted to sell those bonds with a nice capital gain, and just reinvest into other quality bonds at par or at a slight discount. Any comments would be appreciated.”

Writing The Bond Guide certainly opened my eyes to a lot of information and advice on corporate bonds that I hadn’t thought of or recognized before. One big issue for many retail investors is the premiums that brokerages charge for corporate bonds and the lack of availability of issues to investors. Certainly more transparency is needed and I’ve linked to articles on this blog in the past where regulators are looking into giving investors more transparency in fixed income products.

Corporate bonds and fixed income investments are different then equities, but certainly no investor can be faulted for selling an investment at any premium over their purchase price. We’re all invested to make money and even though bonds are often looked upon as long-term investments taking profits in the short-term because of advantageous valuations make complete sense. If you understand the risk when you invest then taking the reward becomes a very easy decision to make.

The difficulty with selling portions of your current fixed income portfolio at any point in time is replacing the issues you plan to sell with buying bonds of similar credit quality, interest rate risk and duration. There may be other corporate bonds that are currently trading at larger discounts, but those issues may be trading at those prices for specific reasons that may not appear at first glance.

One example would be if you’ve bought a bond from company ABC Incorporated and there is now another issue trading at a larger discount. With all risks being equal making a switch by selling your bond at a premium and buying another at a discount makes sense from a reward perspective. Why wouldn’t an investor lock in a gain and attempt to replace their investment with one of similar features and prospects?

The difficult task is when an investor looks to sell one bond and buy another from a different sector, different company or the bond has inherently different risks than what you previously held. The strategy that the anonymous reader is suggesting is similar to how many investors in preferred shares behave in the fall each year for tax-loss harvesting. By selling their preferred shares in one series to buy another series from the same company they often achieve a similar yield and end up crystallizing a capital loss against gains from other investments.

The choice between which bonds to sell and replace will depend on the individual investor, but certainly there is a strong case for protecting your gains by selling into strength and then re-investing into better prospects. I do this myself with individual equities and fixed income investments should be no different as long as an investor understands the costs and risk of their decisions.

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