High and dry – There is a reason some fixed income investments are known as ‘junk’ bonds


When will investors realise there is a difference between a promise to pay and actually coming up with the cash? We only ask because last month provided two more shining examples of the extremes income-seeking investors are now prepared to go in their quest for yield – and about which The Value Perspective has been warning for around a year.

Almost to the day in fact in the case of ‘PIK Toggle’ bonds, which we first highlighted on 8 October 2013 in Take your PIK. At the time, we described them as “a little-known financial instrument” although investors may be somewhat more aware of them now – and particularly those who took a piece of the £205m six-year PIK note issued by Phones 4 U this time last year.

No doubt they were attracted by a headline yield of 10% although, following the collapse of the mobile phone retailer in mid-September, their holdings are all but worthless. Perhaps the knowledge the issue was brought to market principally to fund the distribution of a dividend to the company’s owners will be of some small comfort to them.

Perhaps the best that could be said of this sorry episode is that the genuinely high yield of 10% should have been a clear signal of the genuinely high risks the issue posed for its investors. For in the current environment, it would appear that yield height, like beauty, is a quality that is very much in the eye of the beholder.

In the darkest days of the financial crisis, the yields on European junk bonds – that is, fixed income instruments assessed as ‘BB’ or less by credit ratings agencies such as Standard & Poor’s (S&P) – spiked as high as 25%. By the start of 2012, the yield on the JPMorgan European High Yield index was down to around 10% and, come the end of last month, it stood below 4.5%.

What then are we to make of the €500m (£390m) issue of a five-year bond paying just 1.25% that Lufthansa was able to get off the ground in early September? This was incidentally more than could be said for many of its planes as the German airline, which is rated BBB- by S&P, was hit by not one but two pilots’ strikes in the same week.

Clearly the success of the issue was great news for a company where returns on capital invested have only exceeded the cost of capital in one year out of the past decade – though perhaps not so much for everyone else as it suggests risk continues to build up in the system. It also suggests income-seekers now really need to be looking beyond high or rather ‘high’ yield.

We have mentioned before the quote attributed to John Maynard Keynes that “The market can stay irrational longer than you can stay solvent”. Apparently some bond investors can stay irrational longer than The Value Perspective would have believed possible.


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