As of midsummer, Goldman Sachs had an issue that was trading under $26 with a current yield above 6%. Despite its long-dated maturity, it’s callable in November. If that happens, a new investor will be out more than 8.5%.
Phelps advises to watch for periodic sell-offs, as we saw at the beginning of the year, which can quickly send prices below par, creating buying opportunities.
Baby bond yields are often set at fixed rates. But some pay floating rates, based on a set spread over LIBOR. And some bonds start off with fixed rates and then transition over to floating. While this feature can reduce yield, floating rates are not necessarily a negative thing. In fact, they reduce a bond’s volatility because its price doesn’t need to fall for the bond to adjust to rising yields.
Just as they could with any other bond, issuers could default, leaving investors with non-performing paper that’s worth a lot less than what they paid.
Credit ratings may guide investors away from this risk. Most existing issues’ ratings range from “AA+” to “BB.” Some issues are not rated. That doesn’t mean they are lousy buys. Some companies simply don’t want to pay for a rating if they have a well-established reputation and if underwriters think they can easily dispose of these bonds.
But investors must always do their homework to determine if the issuer will likely be around and paying during the life of the bond.
Investments
As the select list of bonds below shows, there are various opportunities. During the beginning of the year there were lots more. JMP, one of the last remaining boutique brokerage firms, saw its 8% (Series B) bond sell off below $20 in mid-February. Now it’s trading at $25.35. Since it’s now callable month to month, a new investor could stand to lose more than 6% if the bond gets called next month. JMP Series C is now a safer bet (see table).
Dutch insurer Aegon has an 8% bond, which was also traded around $25 in late winter. Now it’s well above $27. Though its initial call date is still 20 months out, buying now could result in a fractional loss if the insurer decides to call this high-coupon security.
Seaspan is regarded by many industry observers as among the best-managed container ship leasing firms in the industry. But the firm has gotten nicked by the slowdown in world trade and its major reliance on China. Still, its 6 3/8% bond due in April 2019 may be worth a look. Trading above par, the bond’s current yield is still over 6% and if held until maturity (there’s no call feature), an investor stands to walk away with an annual return of 5.74%.
A baby bond for eBay due in 2056 is currently yielding 5.6%. If called in March 2021, the annualized return would be 4.22%.
Let’s compare this with eBay’s 4% $1,000 corporate bond due in 2042, which is yielding 4.45%. That’s not much higher than the baby bond’s yield to call. And if held to maturity, the more expensive corporate bond yields about 90 basis points less than the longer-term baby bond. The baby bond appears to be more attractive.
As Daniel Kelsh, senior fixed-income strategist at UBS Wealth Management, puts it, “especially in this higher-valued environment, it’s more essential than ever to do the math to identify opportunities and risks with baby bonds.”
This is not quantum mechanics. So when the next sell-off comes, crunching the numbers will be a worthwhile thing to do.