Fixed income investors are
continually looking for high yielding investments with stability of principal.
It has been that way for decades. Today is no different either. For years, the
high yield bond market provided more than ample income for investors and in
some cases capital appreciation of their investment. That has all changed over
the past year.
continually looking for high yielding investments with stability of principal.
It has been that way for decades. Today is no different either. For years, the
high yield bond market provided more than ample income for investors and in
some cases capital appreciation of their investment. That has all changed over
the past year.
Share prices of high yield
bond ETF’s have declined on average -15.33% over the past year while yields
have remained stable or increased in some cases due to price declines. Some
investors face another problem, where can they re-invest surplus income. Both
situations are very troubling for fixed income investors today.
bond ETF’s have declined on average -15.33% over the past year while yields
have remained stable or increased in some cases due to price declines. Some
investors face another problem, where can they re-invest surplus income. Both
situations are very troubling for fixed income investors today.
Since the beginning of the
year investors have seen extremely high market volatility for a plethora of
reasons which we will not go into here. Despite all the hoopla in the news and
talk by pundits, fixed income investors questions have not changed. They remain
the same and they need answers.
year investors have seen extremely high market volatility for a plethora of
reasons which we will not go into here. Despite all the hoopla in the news and
talk by pundits, fixed income investors questions have not changed. They remain
the same and they need answers.
Today, I am going to share an
idea which may address the fixed income investors questions. This is a little
known area to many investors. It is called Exchange Traded Debt (ETD’s or Baby
Bonds). They trade on the stock exchange like a stock, but they are actually
debt of corporations.
idea which may address the fixed income investors questions. This is a little
known area to many investors. It is called Exchange Traded Debt (ETD’s or Baby
Bonds). They trade on the stock exchange like a stock, but they are actually
debt of corporations.
ETD’s or Baby Bonds are debt
issued by a corporation in denominations less than the normal bond denomination
of $1,000. In fact, most ETD’s are issued in $25.00 denominations. They all pay interest, usually quarterly,
unlike most bonds which pay semi-annually. There is no preferential tax
treatment on the interest paid.
issued by a corporation in denominations less than the normal bond denomination
of $1,000. In fact, most ETD’s are issued in $25.00 denominations. They all pay interest, usually quarterly,
unlike most bonds which pay semi-annually. There is no preferential tax
treatment on the interest paid.
Now, let’s look at
what happened over the past year (2/13/15- 2/12/16). Below are a few
interesting data points which support why investors may want to consider ETD’s
as an income alternative. Before we look at that data, keep in mind the ETD’s
selected are all investment grade securities vs. high yield bonds which are non-investment grade.
High Yield ETF’s * IG – ETD’s **
Average
Change in Principal/ Price Only -15.33% -2.83%
Change in Principal/ Price Only -15.33% -2.83%
Average
Current Yield
6.91% 6.38%
Current Yield
6.91% 6.38%
Standard
Deviation
5.71 2.15
Deviation
5.71 2.15
Ok, this all sounds great, but
what is the down side? The downsides are the spreads are a little wider than
one would expect. So, you do not want to use market orders when buying or
selling. Limit orders only. Next, you are investing in individual issues, so
you do not have the diversification of a ETF.
what is the down side? The downsides are the spreads are a little wider than
one would expect. So, you do not want to use market orders when buying or
selling. Limit orders only. Next, you are investing in individual issues, so
you do not have the diversification of a ETF.
The key to investing in ETD’s
is to focus on investment grade issues. Investment Grade ETD’s carry a lower
default risk, yet they provide yields equal to high yield bonds. Below is a
sample of investment grade ETD’s. You see issuers like Prudential Financial,
U.S. Cellular, Tennessee Valley Authority and even Raymond James Financial.
Some ETD issues are even secured with real estate.
is to focus on investment grade issues. Investment Grade ETD’s carry a lower
default risk, yet they provide yields equal to high yield bonds. Below is a
sample of investment grade ETD’s. You see issuers like Prudential Financial,
U.S. Cellular, Tennessee Valley Authority and even Raymond James Financial.
Some ETD issues are even secured with real estate.
One last point here. In the
event of a corporate bankruptcy, bond holders (ETD’s) are in line ahead of
preferred and common stock investors. A small nuance, but something to consider.
I say this because some investors confuse ETD’s with preferred stocks. ETD’s
are not stocks, they are debt and pay interest. They just trade on the stock
exchange like a preferred stock or high yield ETF.
event of a corporate bankruptcy, bond holders (ETD’s) are in line ahead of
preferred and common stock investors. A small nuance, but something to consider.
I say this because some investors confuse ETD’s with preferred stocks. ETD’s
are not stocks, they are debt and pay interest. They just trade on the stock
exchange like a preferred stock or high yield ETF.
Notes:
* Data
compiled from a Composite of the 10 Largest High Yield ETF’s.
compiled from a Composite of the 10 Largest High Yield ETF’s.
** Data
compiled from a Composite of 40 Investment Grade ETD’s.
compiled from a Composite of 40 Investment Grade ETD’s.
