On the international financial language «trash» or «worthless» (junk bonds) bonds are called high-yield bonds with a high risk. These bonds may be the state with questionable ability to pay, and bonds of companies with poor financial standing or on the verge of bankruptcy.
Novice investors seem strange, why "waste" paper is paid such a high percentage. Yield of "garbage" of securities representing 150-300% per annum (yield reliable bond issuers - 6-9% per annum). But there is nothing surprising here. High yield securities - is compensation for extra risk, which assumes investors buying bonds with a high risk.
Is a lot of investors who buy "junk" and expect the company to buy a lame sound company and pay the loan, and pay the promised high interest rates. However, such investors should be aware that the deterioration in market conditions could lead to failure of the issuer to service its debts to its default. The history of the emergence of "garbage" of bonds is very interesting. The point is that many institutional investors (banks, pension funds, insurance companies) an opportunity to invest in corporate debt has been legally restricted to the investment quality of bonds. Bond issuers with low credit quality - with a rating of BB Standard & Poor's and Ba Moody's - prior to the 80-ies are not in demand. It is because of their exclusion and they are called "garbage." In the United States until the late 70-ies, all new bond issues intended for public placement, have an investment rating. The only publicly traded "trash" bonds are obligations of issuers that have received a downgrade (decrease rate) because of the deteriorating financial situation and lost their investment quality (they called fallen angels - "fallen angels").
The revolution in the market of debt
Revolution in the bond market made a Milka Michael (Michael Milken), subsequently received the nickname "King of garbage bonds. He believed his father-founder of the market "garbage" of bonds.
Studying statistics for the market of corporate obligations, Milka concluded. First, debt securities with low credit ratings in the long term show better returns than bonds with higher rank, in spite of the increased risk of default. Secondly, the yield of corporate bonds is cyclical in nature: they show the best results when there is gloom in the market, and worse - when the market is "overheated", and investor confidence limits.
Based on this Milka found that the "garbage" bonds really are not "rubbish", and their profitability depends on the nature of market expectations. As a result of these findings and the subsequent practice Milkina and his followers on the stock exchange in the U.S. by 1983, more than a third of all corporate bonds in circulation were non-investment rating. The reasons for this rapid growth in emissions of "garbage" of debt is simple. First, these securities were extremely attractive tool for corporate borrowers - has publicly traded bonds typically have a lower percentage than sold through private placement, and impose fewer restrictions on the activities of issuers. Second, the paper is much more interesting for investors.
Studies show that on bonds with a lower rating, investors receive a higher income, adjusted for risk. Risk premium (premium to interest rates on risk liabilities) of bonds with rank higher than a reasonable probability of default, ie, real loss for the obligations of companies that declared its insolvency, more than offset by higher interest payments from other companies.
Therefore, investors buying a diversified portfolio of high yield bonds were the best result compared with those who have acquired a portfolio of debt with an investment rating. And it is even with the losses from those securities in which the issuer announced defaulted.
No analysis can not do
High-yield bonds are considered to be a tool for the most aggressive investors, not only consciously going to take risks, but also ready for a serious loss in the event of default.
To work with "trash" bonds requires a complex analysis that includes the study of the current economic situation, forecast trends in interest rates, the identification of promising industries and companies, assessing the financial situation of the particular issuer, the calculation of potential yield bonds. Unprepared investor in 99 cases out of 100 with a similar task can not do.
In addition, when building a portfolio of "garbage" commitment is necessary to pay special attention to diversification. However, not every investor tools at his disposal would create a broad portfolio of these debt instruments. In this situation the best solution seems to buy the shares "garbage" of bonds, the initial investments that range from $ 1 to $ 5 thousand.
If you select "garbage" mutual fund should take into account the level of costs (it should not exceed the average for this category - 1.3% to date) and stay on as manager (preferably more than 5 years). For the category of funds "garbage" bonds most often used Lipper High-Yield Bond Index and the Lehman High-Yield Index.
If you talk about the issuer "garbage" of bonds, has identified the following groups:
- Rising stars ( "rising star" - young, dynamic company, not having a long operating history, size, assets or financial stability needed for the investment rate);
- Fallen angels ( "fallen angels" - companies that once had an investment rating, but lost it due to financial constraints);
- High-debt companies (companies with high debt);
- Capital-intensive companies (capital companies are forced to go to market "garbage" of bonds when they can not cover its capital requirements from its own funds or bank loans).
It should also be remembered that the choice of "garbage" bonds should be approached very selective and focus on the best of them, with a rating of BB. Do not forget about the risks that are an integral part of the "wastelands" of bonds. These include:
- Interest rate risk (in terms of growth rates of new bonds will be issued with a higher coupon, leading to lower prices are already in circulation and bonds, making them less attractive);
- The risk of default (meaning the borrower's inability to service and repay its debt obligations);
- Reducing the risk rating (the deterioration of credit quality of bonds in the eyes of rating agencies is forcing investors to doubt the solvency of the issuer, which leads to lower market prices of debt securities);
- The risk of inflation;
- The risk of revocation (the probability that an issuer sells its right to withdraw the bond until maturity).
Time to buy
The well-being of the economy - an essential condition for the success of investments in the "garbage" bonds.
Today, most U.S. companies with non-investment rating has heavy burden of debt, which in the case of sustained economic recovery will boost sales and make it easier for borrowers servicing their debts.
In addition, the initial phase of economic recovery, an increase in interest rates. This leads to a reduction in the cost of more robust debt instruments (such as government obligations) and increases the attractiveness of "garbage" of bonds.
With the restoration of economic growth reduces the risk of default, and if the rates on Treasury obligations under these conditions are increasing, according to high-yield bonds are reduced. Indeed, reduced risk premium which investors demand as compensation for the likelihood of default.
The scandals surrounding fraudulent corporate accounts of large companies in 2001, the negative forecasts about the state of the American economy led to increased profitability "garbage" of bonds. Because of the increased perception of risk (perception of risk) corporate borrowers have to offer investors higher interest rates. But next year, analysts' forecasts for further growth in revenue for investment in "garbage" Bonds are not true. This was due to the losses associated with a series of bankruptcies, as well as lowering the credit rating of telecommunications and energy companies. The deteriorating financial condition of issuers of these two sectors has led to stagnation of the market of corporate obligations.
"Garbage" Bonds play in 2003. Debt securities of high quality, ie with an investment rating, have increased in price, becoming the focus of investors. Naturally, this has reduced their attractiveness because they are no longer cheap. Now it is the turn to look at corporate bonds of lower quality.
In 2004, the demand for "garbage" bonds have otherwise as a "madman" is not called. Companies sought provorachivat deal and attract investors as quickly as possible, placing the action in a matter of days. Since January 1, has been issued high-yield bonds by about $ 42 billion, that is, the annualized growth rate of 75%.
And we are on different times, bonds of Russian companies also are trying to classify as "garbage." However, this does not always correspond to reality. Although formally the Russian corporate bonds fall under the definition of "wastelands" (the rating can not exceed the point B - the sovereign rating of Russia), it is unlikely that they are.
First, they can not be attributed to the high yield. If the result of Russian ruble yield corporate bonds (amounting to 18-22%) to the currency, it turns out that the latter would be rather low.
Secondly, the risk assessment of many Russian bonds are clearly inflated by international agencies. Their methods are constructed in such a way that in our conditions, they focused less on the borrower's business, but for country risks. Raise the rating the country, and after him popolzli ratings of Russian companies, although there is nothing fundamentally has changed.
Many market participants are among the reasons that impede the development of "garbage" of bonds, called tax on the issuance of bonds, which makes corporate bonds at a disadvantage in relation to promissory notes and gosobligatsiyam for which a tax on emissions is not taken. Tax deductions, making the issuance of bonds more expensive, adversely affect the ability of enterprises to attract borrowed funds. Other market participants are calling for the imposition of different levels of taxation (progressive scale) depending on the duration of the bonds issued.
Reducing the tax would allow issuers to offer greater returns to investors, which may cause the outflow of money from the market of debt and further complicate the conditions of public borrowing. Criticism is of the order and advance payment of the tax, meaning that the issuer will have to pay it even before the fund-raising in the market. In addition, if the placement breaks down (in case of refusal to register or because of incomplete placement), tax payments are not refundable.
It is criticism and complicated procedure of state registration. It lasts for months, and during this time, experience has shown that conditions can change greatly.
Quite inexplicably looks like the ban on trade in bonds before the end of the period of placement, deprives underwriters to maintain quotes in the secondary market. Where will the liquidity if the investor bought a bond issuer can not sell it, until the deployment of the entire issue.
From profits to losses, a step the current volumes of the Russian market "wastelands" of bonds is very modest. However, there in the last 1-2 years, the growing number of investors willing to knowingly take risks for higher incomes, would increase the size of the market. This will help and medium-sized businesses, because it is evolving and, therefore, desperately needs investment, and is the issuer of the majority of "garbage" of bond issues.
Already, investors are not confused by the appearance of the stock market bonds with high credit risk. During the first four months of 2004 on the Russian stock market has been posted 8 times more high-risk bonds than for the same period last year, while their share in total re-placement of securities has increased twice - up to 15%. According to experts, this proposal is a direct proof that the stock market becomes a tool for bringing money into the growing economy.
July banking "crisis of confidence" was a logical and inevitable consequence of the financial stabilization (low inflation, stable exchange rate, low rate of return on the bond market). But problems in the banking sector (the withdrawal of licenses from a number of financial institutions) will lead to further increases in the market "garbage" of bonds. However, analysts skeptical about the ability to earn them, but to lose, and everything is quite simple. Because when it comes to the "garbage" of bonds, from profit to loss of one-step.
Roman Zubarev
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