Be “Dumb and Rich with TD Circ 570’s”

By Travis Johnson, Stock Gumshoe, December 16, 2008

“If this promise resulted in you becoming a millionaire in under 5 years, safely and legally…would that be of interest to you?

“In fact, if this promise allowed you to have in your portfolio right now, investments that were legally obligated to pay you 120%, 102%, and 73%, in a little over a year, could I keep your attention for the next three minutes?”

Recession or no recession, great copywriters still know how to get us excited in the service of a cause … with the cause being, in this case, the fact that Steve McDonald’s newsletter needs some new subscribers.

This come-on is one of the funner ones I’ve seen in a while — they hit on a few of the tried and true selling techniques that always get attention: They use a lot of pictures — including a picture of the fancy car you could drive if you subscribed to this newsletter and (naturally) got rich, and a faked-up picture of the “bar napkin” on which this simple strategy is explained; they make up a new term to obfuscate the nature of a fairly well-known investment strategy (the “TD Circ 570”); and they build up the newsletter editor to the point that we’re shocked that such a great and wealthy man would spend his time serving the likes of us — they even give him a nickname, “The Pilot.” You can see the ad here if you want a taste, but don’t forget to come back for some level-headed discussion when you’re done.

Good stuff, indeed.

But what we care about is what the strategy is, whether we can understand it on our own, and whether it makes any sense to subscribe to a newsletter just to learn what a TD-570 is.

So what are they promising in exchange for your hard-earned $995 subscription fee?

“It doesn’t involve Stocks… Government Bonds… Currencies… or even Options.

“And the payouts are obligated by law, basically assuring extremely low risk levels. In fact, back testing the strategy to 1920 proved that it was 99.77% risk-free.”

So if you’ve been around a while here in the hallowed halls of Gumshoe University, that probably already tells you what we’re looking for. But how do we get ridiculous returns like they promise while remaining 99.77% risk free?

They really stress the safety of this strategy, which makes sense during these times, when even the wealthy folks who used their sharp elbows to get an account with Bernie Madoff found out that he “madoff” with their money.

“In fact ‘the Pilot’ says you could be the dumbest person on the planet and still profit BIG from it (he is a bit blunt…but I guess when you spend years flying fighter jets to protect our country – mincing words isn’t a top priority).

“‘The Pilot’ explains that you could safely make up to 65% returns every single year investing in his strategy.”

And the tease continues ….

“I don’t want to get your hopes up for retiring on some “get rich” quick scam [ed. note: hmmph] with little, to no, start up money.

“This is a safe, financial marathon…not a reckless sprint.

“You will need at least $5,000-$10,000 to utilize this strategy…

“… say you start with $10,000…this strategy could crown you a millionaire in less than ten years with no additional financial outlay.

“That’s just a strong dose of honesty.”

The key word there, of course, is not “honesty” — it’s “could.”

They also show us a nice-looking spreadsheet of potential returns based on this possible 65% return, giving you a ten year return of some 14,856%. Sounds good, if you can get it.

That is, of course, just an illustration of the power of compounding returns, which we’ve talked about in this space a few times in recent weeks — it’s the remarkable boost to returns that you can get if you reinvest your income back into your investments. Often this is used to show how important it is to reinvest dividends back into stocks, as with the 424 Dividend Boost or 801K strategies from Tom Dyson, but today they’re talking about reinvesting coupon payments.

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Because yes, once again we’re dealing here with a teaser for corporate bonds.

Or, as they tease it:

“It’s Like You’re “Vinnie The Loan Shark”… And It’s Time To Collect!”

The teaser is for a newsletter called The Bond Trader, and, though this ad is quite a bit stronger and promises much more, we have looked at ads for this new service before — they teased it back in September as a way to “bulletproof your portfolio.

And the TD Circ 570 term that they made up? It’s hard to imagine why they would use this particular term, but perhaps the closest term that makes any sense is Treasury Department Circular 570, which seems to pertain primarily to insurance companies and sureties for reinsurance of federal debt, and lots of other stuff that will put most people immediately to sleep. Perhaps there’s something in there about using investment grade bonds as surety collateral, but from a quick glance at the circular it doesn’t seem to particularly apply here unless (and I doubt this is true) McDonald is focusing on insurance company debt. Individual investors are likely to focus on fairly liquid corporate bonds that are easily traded through brokers at somewhat fair prices, so we should probably assume that this is what the Bond Trader is still telling folks to buy.

The Bond Trader promises to steer you toward investment grade bonds, which means we’re dealing with something a little different than the True Income newsletter from Stansberry, which we’ve written about before and which seems to focus primarily on junk, or low-rated, bonds (those teasers were for “Scheduled Distributions” and “Secured Investment Contracts”).

Both of these services jumped up pretty quickly earlier this year to fill a perceived vacuum — there are newsletters that focus on bonds, income, and debt, but not that many of them, and very few that are aggressively marketed to individual investors. Now there are at least these two that hit my mailbox at least once a week, and with corporate bonds generally inexpensive now and investors worried about income, I expect we’ll see many more such publications come to life in the near future.

But the promised returns are almost as over-the-top as the junk-bond teasers — how can these “TD Circ 570s” give you such high returns with investment-grade bonds and a 99.77% probability of getting repaid?

The returns are indeed impressive — they provide three examples of TD Circ 570s that are in this newsletter’s portfolio right now …

“A corporate bond, discounted from $1,000 down to 467.50. It comes to maturity February 23 of 2010 with an annual 4.2% dividend payout. That’s a 120% total return with a 99.77% certainty for payout”

Incredible, no?

If you don’t know the corporate bond market at all, there are a few things to know:

  • Bonds are loans that are actively traded, so you can buy and sell them like you do stocks (though the market is sometimes less open to small individuals, most brokers can do this for you).
  • Bonds have a face value, which is what that $1,000 would be, the original amount of the loan, and that’s the amount they are obligated to pay you back when the bond matures.
  • There is also a coupon rate, which is the interest payment that is usually due quarterly or semiannually, and is based on the original loan amount.
  • Bonds are graded by the ratings agencies to give them a score that indicates how safe those analysts believe the bond is — really, whether or not the company can make payments and pay back your principal when its due. “Investment grade” corporate bonds like these are supposed to have a very low chance of defaulting, they’re not nearly as safe as AAA-rated bonds like those from Berkshire Hathaway or General Electric, but are far safer, in theory, than junk bonds that are rated in the low-Bs or Cs that are, at the lowest levels, at imminent default risk.

So this is a $1,000 bond, which is typical, but it’s trading at less than half of the principal value. If the company is making payments, as one would certainly expect with an investment-grade bond, then those payments would be 4.2% on that $1,000 face value, so you’d expect to make $42 in income on your money. Since it only cost you $467 instead of $1,000, that means your dividend is more like 9% … but what really boosts the return is when (if) you get repaid when the bond matures, because you would have to be repaid $1,000 for your $467 investment. That’s how returns get truly massive for discount-priced bonds.

Of course, bonds don’t get priced like this just for fun, and the bond market is full of savvy investors — even though individual investors are not often active in the corporate bond market, institutional investors certainly are, and if they thought this bond was really investment grade, and was really likely to pay off at maturity, they would be all over it. Of course, it’s quite possible that the market is misjudging any particular investment, but if the potential one year return is over 100% we need to be very careful about trusting that “investment grade” label.

Perhaps the key thing to remember is that the 99.77% number that they throw around is less than useful when looking at any individual bond. And that the world is justifiably skeptical about the grades assigned by the ratings agencies.

So it may be that, historically, corporate bonds that are rated investment grade have a near 100% guarantee of paying off. But with trust in ratings agencies falling precipitously over the last few years, and clear conflicts of interest in their business models, “investment grade” might no longer mean what it meant 50 years ago. And more importantly, we’re not talking about averages or indexes — we’re talking about buying individual bonds, which means the only thing that matters is whether YOU think the company can pay you back.

Can we figure out what these bonds are, in case you’re interested in riding on “The Pilot’s” coattails?

Well, from the “clues” provided there’s not an easy match for this bond in the major bond screening databases I’ve reviewed, but there are a few things to note that might serve to help “cool the jets” a bit:

Of the bonds that mature right around February 23, 2010 that are included in some of the big listings, those that are rated investment grade trade right around $95-$97 per $100 of principal (not $47, as the teased bond is). The only one that even comes close to matching this teaser is … Ford Motor Credit Company. You can get a Ford bond for fifty cents on the dollar, with coupon payments of 5-6% and a yield to maturity of about 100% in a bit over a year.

Of course, Ford bonds are currently rated as junk — CCC by most of the raters. According to one of them, Fitch, CCC means: “For issuers and performing obligations, default is a real possibility. Capacity for meeting financial commitments is solely reliant upon sustained, favorable business or economic conditions.”

Ford is doing better than GM or Chrysler, for sure, but if you think they’re experiencing “sustained, favorable business or economic conditions” … well, I can’t help you.

To be clear, I don’t imagine this is the bond that they’re talking about — but the numbers are similar, so the odds are that any stock now trading at less than half of face value is facing problems that are in some way comparable to those that are staring Ford in the face right now. Maybe Ford Credit bonds will be a great buy right now, they may well avoid bankruptcy, and even if they go bankrupt it’s quite possible that there’s enough collateral to get 50 cents on the dollar for bondholders, I don’t know … but those are the kinds of things you should be thinking of when you lend money to a corporation.

They tease two more, I’ll try to give you a taste:

The second one is teased as trading for $600 on a $1,000 principal, with a coupon rate of 4.5% and a maturity date of March 15, 2010. If we’re still looking for an A- rating on this one, the only major company that I found which is fairly close is …

DaimlerChrysler North American Holding. I don’t know whether this debt is ultimately an obligation of Daimler itself, or of Chrysler, which they sold 80% of their interest in (just in time, it appears). But it is still rated A-, so odds are it’s not just an obligation of Chrysler, since they seem to be by far the weakest of the three Detroit automakers (GMAC bonds that mature on the same day are trading at closer to 25 cents on the dollar and are rated as if they will almost certainly default).

Those DaimlerChrysler bonds are trading a bit above $600, at $770, but they may well have gotten lower in the recent past, and the coupon rate is 4.5%. No guarantee that this is the one “The Pilot” is holding, but it does match the general risk parameters you’re likely to see from an A- bond trading at a firm discount to a near-term maturity payoff.

And the third teased bond:

Discounted from $1,000 to $771.25, with a coupon payment of 8% and a maturity date of June 8, 2010.

The only one I came across that’s even close is Dow Chemical, which has a bond with an A- rating and a coupon rate of 8.5%. Unfortunately for those who might be excited about this one, it’s trading right around par — meaning it’s trading at just about the fair price of the principal, so it will cost you $1,000 to buy the $1,000 bond, and your yield will be just that 8%, no huge bump from paying back the principal in a heavily discounted bond. It’s possible that this bond did reach a big discount when the world was in full-blown panic a few weeks or months ago, but right now that’s about what you can expect from a solid company with a mid-range investment grade bond and a year and a half to principal repayment: an 8% annualized return.

So I can’t tell you exactly which bonds Steve McDonald is recommending right now — I can tell you that he is certainly not alone in recommending corporate bonds, you’ll now see articles about investing in corporate debt in most major investing magazines, and you’ll hear them talked about on CNBC quite frequently. Many of these bonds have been truly clobbered in price, so there probably are bargains to be had — but do be mindful that it’s quite hard for a small individual investor to build a diversified portfolio of corporate bonds.

And I would be very careful about making any assumptions about 99.77% likelihood of repayment for any bonds that you buy today — it’s always possible, but it’s clearly not what most major investors are expecting.

If you’re interested in more thoughts on investing in corporate debt, you might revisit a few of my older articles — particularly the “Scheduled Distributions” article from last month about lower-grade bonds, and my previous article about McDonald’s service, which includes more details on how to use my favorite free online bond screener.



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December 16, 2008 11:14 am

Like you mentioned institutional investors are the big boys in this domain. This is a pretty competitive business and if a bond is valued at 50% off face value then there is usually a very good reason. Its true that if the company defaults you have seniority over shareholders but you might be cooling your heels quite a while before you get your money. I would much prefer going into a reputable bond fund and let these guys do the heavy lifting.

December 16, 2008 11:48 am

Love the new look and keep up the “VAN-tastic” sleuth-manship!