Bonds: Total Market

(New York)

Investors in fixed income need to be aware of a brand new loophole that was just opened to Delaware-based companies. A new provision allows companies (specifically LLCs) to split in two and divide their assets and liabilities between them as they see fit. The rule would allow companies to put certain assets beyond the reach of creditors, for instance putting debt in one entity and assets in another. The big problem is that most bonds don’t have provisions to protect against this behavior because it didn’t exist as a concept or legal process until it was approved this month. Another issue is that many contracts are written from the perspective of New York law, but that might have not much weight with Delaware-based rules.

FINSUM: This is a messy problem for anyone who owns private or smaller company debt. We thought investors should be made aware right away.

(New York)

One of the ways that investors or advisors might think to diversify their risk is to invest in a number of different managers. The reality is, however, that many of those managers, especially within an asset class, will all have similar looking portfolios, which means you may be much less diversified than you think. The obvious analogue is index tracking funds. There would be no point in buying multiple ETFs from different providers that all track the same index. Yet that is what investors are doing in some markets. This concept is particularly relevant for the riskier end of the credit markets right now, where the market seems to be poised for the same kind of correlated fall as happened during the Crisis. In CLOs for instance, many of the largest loans are held by a majority of the major managers.

FINSUM: This seems like a smart and timely warning. Correlation can doom even the best diversification efforts, especially when it is credit driven.

(New York)

Retail investors have often had trouble accessing the corporate bond markets. Bond are traded in $1,000 increments and usually move in multi-million Dollar transactions, putting the asset out of the reach of most (new corporate bond ETFs aside). However, there is an easier way to directly own bonds—so-called baby bonds, or bonds sold on stock exchanges like the NYSE in $25 increments. The total market size for the bonds is around $20 bn and the securities are usually senior unsecured. Issuers like them because they are callable after just five years. Frequently the bonds have higher yields than their convention counterparts. Finally, they pay interest four times a year rather than twice.

FINSUM: This is an interesting if niche asset class, but there is some appeal in the unique terms these “baby bonds” have. There are also some big name issuers like AT&T and eBay.

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