Beware of high yielding securities
Something like $4 billion or so in subordinated bank debt has been issued in the past year, delivering investors yields as high as 8 per cent, but often closer to 6 per cent.
But investors jumping on this yield bandwagon should be wary that in many ways they are not being compensated properly. Banks use these “subordinated bonds” because they have bond-like characteristics, providing a fixed income return. But the fact is, they are more like equity if the proverbial hits the fan. If there is another financial crisis, the issuers have the option to extend them out for as long as 70 years.
So, if things go south, instead of getting your investment back in five years, you could find out that you are holding a piece of paper that is worth 60 per cent of its original value.
Not surprisingly, fund managers like John Corr of Aurora Funds Management, are aware of this.
“Investors in search for yield are taking on long-term risks that they may not realise. If (there's another financial crisis) these things have all the downside and none of the upside.
“If there's a recovery, you're better off buying a growth company like a small cap, where you are taking on the same downside but you're getting a lot more upside.”
Recent issues include CBA PERLS VI notes, and Westpac's (ASX code WBCHA), while Suncorp's (SUNPC) and Bendigo Bank's (BENPC) are due to be issued next month.
Other corporates have been getting in on the act in the past year. These include Woolworths (WOWHC), AGL (AGKHA) and Crown (CNGHA).
Savvy investors are buying high growth small caps and short-maturity instruments
Aurora, which uses a range of strategies to make money, is also on the hunt for yield. One strategy is to small caps with growing dividends. Another is purchasing paper with short maturities, which many retail investors are selling out of in order to invest in the heavily marketed subordinated bond issues.
“We're finding investors are selling short-term paper and we're definitely taking advantage of the liquidity,” says Corr.
The fund has a number of positions in these securities, but a large one is in ANZ preference shares, which mature in June 2014 (ANZPB). These currently provide investors with a yield of 6.5 per cent, although Corr says his fund bought in when they were delivering 7 per cent.
If you are taking on risk, you need to be appropriately rewarded. If you are investing in one of these so-called “hybrid securities” you need to realise that getting income today could mean you lose your shirt tomorrow.
Small Caps are often thought of as being among the riskier asset classes, and with good reason. But the important factor in their favour is that investors are compensated for that risk.
Some of the stocks Radar likes are on double-digit yields, while others are on low yields that are forecast to grow. The fight for capital has never been tougher for the small listed companies of this world, which lies behind the unbelievably good value in the sector.
Takeover activity at the smaller end
Oil rig services provider Neptune Marine, whose shares spiked 50 per cent this week, has been made an offer by 19.5 per cent holder Singapore based MTQ Corp, which lobbed a cash offer of 3.5 cents a share yesterday, just after the company signalled its intention to consolidate its shares.
As has been well-chronicled, Elders (ELD) is now firmly on the block this week in the wake of aggressive moves by competitor and 12.4 per cent share holder Ruralco.
Expect to see more of this sort of action at the small end as corporates take advantage of good value in the sector.