Fear rules the bond market and it is in a position similar to a great credit crunch in the 1970s. When fear rules, wise investors have an extra edge because their investing is led by fundamentals and value…not emotion.
First, if you do not have a clear understanding of bond investments see Multi Currency Seasoned Bonds.
Shares are sold on stock markets and bonds are sold on bond markets. Prices are usually dictated by fundamental value in the long run.
The same rule that applies to share markets applies to bond markets. “In the long term markets are efficient and can be trusted because they are ruled by fundamentals. In the short term, markets are unpredictable because they are ruled by human emotion.”
Right now bond markets appear similar where they were in the 1970s (when I made a killing by buying good quality bonds). It appears that the human emotion of fear has caused bonds to be oversold.
For example that US dollar 6.875% 15/09/2011 GMAC bond we used as an example above was for sale yesterday at 34.00. In other words an investor could have bought a $10,000 bond for $3,400. This created a yield potential of 54.27%. Investors would get back $12,062 over three years for an investment of $3,400. They nearly quadruple their money in three years.
This GMAC bond has a junk bond credit rating. The reason for this huge discount is that GMAC may not be able to repay the $10,000 in three years. Investors may lose part or all of their investment . Buying this bond is a speculation and investing in it has a high risk
However, wise investments are available in better quality discounted seasoned bonds.
The current credit crisis has the corporate-bond market spiraling down.
Jyske Bank wrote today:
“The general shortage of risk tolerance has become more and more pronounced
day by day this week. Last week, high yield bonds fell by 1-2 points a day,
this week there have been higher daily declines throughout the entire market.
This trend continued on Thursday. Although some buyers begin to crop up,
buyers are still outnumbered by sellers. However, we sense that some buyers
are prepared to pick up. They have just not yet had the courage to enter
the market in earnest. This means that bid prices are difficult to find here
late in the week.
The bond market has long been under the greatest pressure. Yesterday,
there was a large buyer of protection which prompted iTraxx Xover to
widen. This morning, the index is trading around 725. This is the same
level as when the old series was at its widest level back in February.”
The iTraxx Xover is a Crossover index of bond values. Crossver is often written as Xover, a credit index comprising a mixture of high yield and higher yielding investment grade names. Crossover indices exist in North America (CDX NA XO) and Europe (iTraxx Crosssover).
What this means is that bond prices continue to drop and yields rise.
All investments have risk…now more so than in most times. The key to good investing is to make sure you are paid an adequate premium for taking the risk.
As we look at examples above and below, remember that rates change continually so earnings an investor can actually make, may be more or less depending on rates at the time of investment.
Investors can speculate in risky bonds but it is often safer and as profitable to be satisfied with safer bond yields or leverage an investment.
We can see how there has been a flight to safety in the bond market.
Before we do, let’s review what the ratings mean. Here is a comparison of bond ratings shown at bondsonline.com.
Moody’s S&P Fitch Definitions
Aaa AAA AAA Prime. Maximum Safety
Aa1 AA+ AA+ High Grade High Quality
Aa2 AA AA
Aa3 AA- AA-
A1 A+ A+ Upper Medium Grade
A2 A A
A3 A- A-
Baa1 BBB+ BBB+ Lower Medium Grade
Baa2 BBB BBB
Baa3 BBB- BBB-
Ba1 BB+ BB+ Non Investment Grade
Ba2 BB BB Speculative
Ba3 BB- BB-
B1 B+ B+ Highly Speculative
B2 B B
B3 B- B-
Caa1 CCC+ CCC Substantial Risk
Now let’s compare examples of how ratings are affecting yield.
A US dollar Gazprom bond is rated A3e by Moody’s and BBB- by Standard and Poor’s.
The e in the A3e is a further, slightly lower subclass.
This bond has a 7.93% interest and matures June 28, 2013. This bond is offered at the discounted price of 82.25. This creates a yield of 13.08% which is a premium of 10.64% over a US Treasury bond. Investors would pay $8,225 for the $10,000 bond in this example. The bond would then pay $793.30 per annum interest through June 2013. In 4.5 years this is a total interest earning of $3,600. Plus the bond, at maturity returns $10,000 or a total return. This creates a total return of $13,600 on the $8,225 investment. Over the four and a half years the total profit is $5,375 on $8,225 invested or 65.34% (about 14.52% per annum).
However a higher quality bond that matures at almost the same time, HUTCHISON WHAMPOA INTL LTD 6,5% 13-02-2013 that is rated at A3 and A-. This bond is offered at a premium of 100.25 which provides a 6.43% yield which is only 4.12% above the US Treasury bond yield.
If we drop one grade lower and look at the EVRAZ GROUP SA 8,875% bond that matures 24-04-2013 and is rated Ba3/BB-. The bond is offered at a discounted 74.25 price which yields 17.28% or a whopping 14.91% over US Treasury bonds.
These are excellent returns for investment grade bonds…unheard of except in this state of fear.
Borrower Rating Yield
US Treasury Aaa 3.01%
Whompoa A3 6.43%
Gazprom A3e 13.08%
Everaz Ba3 17.28%
GMAC B- 54.27
We can see how the market has rushed to higher quality.
In such troubled times poor quality bonds are more likely to default. Most investors increasingly avoid them and their yields rise. Speculators want a greater premium to take the risk.
We can also see is that compared to the norm, these returns are extremely high in all classes.
Since we have looked only at US dollar bonds, investors with $100,000 to invest (the minimum that Jyske will accept for leveraged accounts can create a multi currency sandwich by borrowing up to one time the investment. US dollar loan interest is in the 4% range.
Imagine the example of an investor who invests $100,000 and borrows $100,000 to invest equally in the three best bonds.
Whompoa A3 6.43%
Gazprom A3e 13.08%
Everaz Ba3 17.28%
The average yield is 12.26% or $24,526 a year interest on $200,000. The loan interest is $4,000. This creates a return of $20,526 on the $100,000 invested.
Even an investor who wants to stay with higher quality bonds in the A range can perk up returns.
$200,000 invested in a 6.43% yield earns $12,863, less $4,000 of interest leaves an $8,863 income on $100,000 invested. That is 8.83% return for upper medium grade bonds.
There is no currency risk in the loan because it is in US dollars and the investment is in dollars as well.
What are the risks?
One risk is that the interest rate on the loan could rise. In this case you would normally just sell bonds to pay off the loan if the interest rate of your loan rose higher than your yield.
However there is another risk…normally one so remote we would barely mention it. With such short term bonds the capital value of good and even medium risk borrowers would hardly ever fall, unless there was some special corporate misfortune. Never would we expect all investment grade bonds to lose much capital value.
These are not normal times though. This is why we may never see such a guaranteed profit potential with such a low risk again.
However in the short term, if liquidity continues to tighten the yield on such bonds could rise even more and their capital value fall further. Be sure to review your liquidity needs with your investment advisor. You do not want to be caught having to sell at the wrong time. Plus if you leverage though a loan…never leverage more than you can afford to lose.
You can invest in the bonds mentioned above via Jyske Bank (American investors can use Jyske Global Asset Management JGAM).
I just finished a long meeting with Thomas Fischer at JGAM to review the updated services that JGAM. JGAM now has an advisory service so US investors can invest in multi currency seasoned bonds. Based on what I learned about the new services Jyske offers Americans, I am personally investing $1 million in a new program to help my multi currency course subscribers understand how to use these services. I’ll review how tis works in upcoming lessons.
Jyske Bank’s Safety Rating
Jyske Bank is Denmark’s second largest bank and I have worked with them for over 20 years. They are my main bankers and investment advisors and have in depth multi currency investment experience.
On October 10 2008, Moody’s affirmed Jyske Bank’s long-term Aa2 rating stable rating. The affirmation of the ratings reflects Jyske Bank’s strong domestic retail and commercial banking franchise, current good asset quality, strong capitalization, and strong risk management. This decision came despite the deteriorated economic prospects in Denmark, particularly in respect of the property market.
New Danish Government Bank Guarantee
Also on Friday 10 October 2008, Jyske confirmed that it had no exposure to Icelandic risk. In addition the Danish Parliament passed a bill that secured all deposits and unsecured claims against losses in Danish financial institutions. The agreement was designed to reassure both depositors and the banking community. It is up to each bank to decide to join the new guarantee scheme. Jyske Bank announced that it will join the new government guarantee scheme. During the two-year programme, banks cannot issue dividends, make share buy-backs or establish or renew share option schemes for managers. The rating of the Kingdom of Denmark is Aaa/AAA with Moody’s and Standard & Poor’s respectively.
For more details on how to buy multi currency seasoned bonds at Jyske bank aand JGAM contact:
US investors contact Thomas Fischer at firstname.lastname@example.org
Non US investors contact Rene Mathys at email@example.com
Until next message, may your multi currency investing bond with high profits.
There is great beauty here in the Blue Ridge as the leaf change begins to take hold. Here is my front yard view now.
The salmons and gold mean its time to think SOUTH, WARM and SUNNY. This will be my Cotacachi Ecuador view soon.
Join Merri, me, Steve Marchant, Kjetil Haugan and Peter Conradsen of Jyske Global Asset Management in Cotacachi Ecuador. We’ll review economic conditions, Ecuador real estate, my entire portfolio, seasoned bonds and investing and business ideas for the months ahead.
Our delegates have a great time as they learn. Here is last week’s group enjoying an organic wine and cheese reception after the course at Bohemia Gallery and Cafe in West Jefferson North Carolina.
Nov 7-9 2008 International Investing and Business Made EZ Ecuador
Stay on for the real estate tour Cotacachi and surrounding areas. See wonderful condos like this for sale at $46,000 in Cotacachi.
Nov 10-11 Cotacachi-Imbabura Real Estate tour
Then travel to the coast. See Vistazul condos like this for $89,000.
With this clubhouse view.
November 12-15, 2008 Ecuador Coastal Real Estate Tour; Quito Real Estate Tour