With the economic recession rippling through the economy, everyone is still looking for safe havens to park their money. While this may mean cash or gold or Treasuries, there are still some decent ways to get a modest return with your money in the current market. One of the most often overlooked segment by the average investor is the corporate debt arena. With the ‘Bond’ moniker, images of low risk and low return dance off to the side while the appeal of potential higher returns in stocks take center stage. But the looming threat of bankruptcy has beaten down a lot of corporate bonds that now trade anywhere from as low as 10 cent on the dollar.
Now one might argue that this discount on a corporate bond is due to the lack of faith in seeing these bonds last until their maturity. While this is a large part of the reason certain bonds are available for cheap, the discount is also due in part to major bondholders (i.e.- investment banks) being forced to sell early to raise capital. Because of the credit crisis, waiting for a semi-annual dividend interest payment doesn’t help enough with short-term cash flow issues experienced by companies bleeding money. So who can benefit from these cheap bonds?
In the normal bond market, you would need a few thousand dollars to buy most of these bond certificates. The major risk factor affecting corporate bonds is the risk of bankruptcy. While a bond holder would not get completely wiped out like a common stockholder, there is a restructuring of debt provisions in a Chapter 11 bankruptcy and a totem pole of who gets paid with the leftover assests in a Chapter 7 bankruptcy. And in the short-term, there is also the potential for a prolonged devaluation of the market price of the bond.
On the upside is the set dividend interest payment of the bond. For corporate debt with a less than stellar rating, these could be anywhere from 6% to 15% on an annual basis. And unlike common stock, which dispenses a dividend at the discretion of their board of directors, bonds will never cut their dividend unless the company is forced into bankruptcy. An extra bonus if you are able to buy a corporate bond at a discount is the gain realized upon the maturation of the security. So if you buy a bond at 80 cents on the dollar, you get an additional 20% gain when the bond is paid back in full in addition to interest earned while you held the bond.
The additional benefit of the current situation is that corporations are working to retire their debt early, while their bonds are selling cheaply. This could provide short-term benefits to the price of the bonds as companies seek to increase cash flow by reducing their short-term interest payment on these bonds. Just like the recent Ford announcement, companies are making offers on their bonds at a premium of their current value, which is far below their full redemption value. If you were an original bondholder you could still hold on to the bond to eventually recoup your investment, but this present a nice opportunity to those that are able to get in close to the bottom. An added bonus is that bonds stay with a company even after it mergers with another company, so if you do stick with a bond it will provide a fairly safe investment vehicle.
Since bonds can be rather troublesome to purchase through most retail discount brokers, there’s another investment security that acts just like a bond. Structured Products Corporate Trusts trade exactly like stock, but have no earnings and an eventual redemption date. They’re pretty much like a simpler version of the maligned Collateralized Debt Obligations because instead of a pool of securities they’re made up of a single corporate bond issue and pay a semi-annual dividend equal to their interest payment. Most are issued at $25 a share with the initial total market value equal to the original size of the bond issue. Ideally they would trade flat until their eventual redemption. At the moment, quite a few like Dow Pharmaceuticals bonds (KVT), Ford bonds (KSK & KVU), Sherwin Williams bonds (KOS & KOB) are trading at anywhere between a 10 and 80 percent discount.
Hopefully this has provided some insight into another potential investment vehicle. Be aware of the potential risks that are still inherent in these securitized products even if they are considered less risky that stocks alone.