The Intrinsic Problem With HY Bonds

Most investors who invest in bonds are going after the “guaranteed interest” that bonds provide. Even with a $1 million, a 2.5% yield will only provide $25,000 in income that will provide unsatisfactory to most people.

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High Yielding Bonds

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It is thus natural that investors would seek better returns by buying bonds with higher yields.

Unfortunately, there is no free lunch in the world. Every percentage point of interest more translates to more risk – even if it is not apparent to investors.

What this means is that investors are taking on a higher likelihood of their initial investment (the principal amount) being impaired down the road in exchange for 1% to 2% more interest a year.

This may all sound very theoretical – but the recent crisis in the Oil & Gas sector has proven otherwise.

The Intrinsic Problem With High Yielding Bonds

Just because you’re investing in a bond does negate the need for fundamental analysis.

Companies typically raise money from the high yielding bond market for expansion. It can be a developer choosing to buy land, a manufacturer buying land and machinery for a factory, a shipping company buying ships and related vessels.

The common thing for all these companies is that their business plan must succeed for them to generate the capital needed to repay back investors.

In others words, investors must be able to assess the likelihood of such projects being successful if they want to get their money back.

When we look at stocks, we look for companies with strong financial positions. We look for companies with fortress-like balance sheets with strong cash flows.

Unfortunately, when you look at high yielding bonds of companies looking to raise debt – these things will be absent which is the exact reason why are they forced to pay the interest rates they do!

 



About the Author

SG Value Investor
I developed my passion for investment management especially equity research at a relatively young age. My investment journey began when I was 20, at a point in time where markets were still recovering from the Global Financial Crisis. My portfolio started from money I saved over the past years and through working during the holidays. I was fortunate to have a good friend with common investing mentality to began my journey towards value investing. To date, we still research and invest in companies together, discussing valuations and potential risks of a company. To date, I manage a fund with a value investing style. Positions are decided upon via a bottom-up approach or smart speculation (a term I came up with when buying a stock for quick profit due to a mismatch in prices in the market due to takeovers/selling of a subsidiary or associate). Apart from managing my own portfolio, I enjoy sharing my research with family and friends, seeking their opinions and views towards the stock. Reading Economics in London, I constantly keep up with the financial news in Singapore & Hong Kong. Despite my busy schedule, it has not stopped me from enjoying other aspects of life. I enjoy a variety of activities in whatever free time I may have – endurance running, marathons, traveling, fine dining, whiskey appreciation, fashion. Lastly, I enjoy meeting new people, discussing ideas and gaining new perspectives towards issues in the world.