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Mastering The Bond Universe

Cover Story


Individual investors have typically bought bonds for safety and predictability and have viewed them as the ultimate buy-and-hold investments. But professionals often trade bonds with abandon, like Sherman McCoy, the self-proclaimed "master of the universe" in The Bonfire of the Vanities. Phil Carlson, a school social worker and Christmas-tree farmer from Hopewell Township, N.J., is an independent investor who trades 10 rather than 10,000 bonds at a time, but he's nonetheless a master of his universe.

Carlson, 49, plays the bond market with aplomb, even investing in the bonds of troubled and bankrupt companies--and he chalks up some admirable results. Just look at daughter Cynthia's college fund. Starting with $6,000 when she was born 17 1/2 years ago, Carlson ran that up to about $100,000. That's a 17.4% average annual return. That money should enable Cynthia, who'll enter Cornell University in the fall, to pay for an Ivy League education. Carlson also started with $6,000 when daughter Cathy was born 16 years ago. That fund now has $60,000--a 15.5% average annual return. And of course, Carlson also manages the personal funds for him and his wife, Carol, a writer and editor.

GOOD JUNK. Carlson has been following the stock market since he was a teenager, but he gravitated to bonds because he likes the more predictable returns. "Management can squander the stockholders' money," he says, "but they have to pay back the bondholders." But that doesn't mean settling for single-digit yields.

Carlson often buys junk bonds, but unlike many masters of the market, he never buys at par. His biggest score came in the early 1980s, when Chrysler Corp. teetered on the edge of bankruptcy. He bought bonds issued by Chrysler Financial Corp., the auto makers' finance arm, for 30 on the dollar. The pros were dumping the bonds like mad, but from his extensive reading, Carlson knew that the bonds were backed by auto loans rather than Chrysler's credit. Eventually, the bonds paid at full value--a triple--and they never missed an interest payment.A few years ago, when Chrysler was beginning to look shaky again, Carlson once again bought Chrysler Financial bonds. But this time, they cost him about 70 on the dollar. Still, he recently sold the bonds at a little over par, for a 43% capital gain. And don't forget the interest, too. Carlson also scored with junk plays in Bal-ly Manufacturing, Public Service Co. of New Hampshire, and most recently, U.S. Home. Of course, he has had his losses as well, in Trump TajMahal Funding, Trump's Castle Funding, and Resorts International.

Bonds also appeal to Carlson because he can quantify his payoff chances. "Let's say there's a 50-50 chance of a company surviving, and I can buy at 20," he explains. "The way I see it, if the company fails, I've lost 20, but if it survives, the bond pays off at 100, and I get $5 for every dollar I put in."

The bond market demands even more patience than the equity market. Corporate bonds are far fewer in number than stocks, and many of them are locked up in pension funds and rarely trade. That means Carlson can't always get what he wants. "You put in an order for 10 bonds, and maybe you get two when you call and wait for the others," he says. Carlson notes that you can always increase the bid to draw out more sellers. But if you pay too much, he warns, you will crimp your returns.

Although he prefers bonds, Carlson sometimes buys stocks as well. He's a strict contrarian, looking for out-of-favor companies rather than hot-growth stocks rocketing up the charts. He recently purchased Johnson & Johnson, which he thinks has been pummeled because of fears of what President Clinton's forthcoming health-care plan might do to its business. "In retrospect, these fears are usually overdone," he says.

To keep up on his investments, Carlson reads financial newspapers and magazines and all the reports from the companies, including the regulatory filings as well as glossy annual reports. "The first time I read it, I may understand nothing," he says. "By the second or third read, I see what's going on." Many investors don't have the pluck and persistence to pore over financial statements well into the night. But then again, not many of them get Phil Carlson's results.Jeffrey M. Laderman in New York

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