Ihave had a Damascene conversion in the last 12 months – and a very profitable one.
I made my first foray into corporate bonds and preference shares back in March, as related in this column in April. I bought Standard Chartered’s 8.1 per cent perpetual preferred stock, and an Aviva 5.9 per cent subordinated direct capital instrument. Both were just about investment grade, rated BBB+, according to S&P, but obscure. This was at a time when some ratings agencies were expecting about a fifth of corporate bond issuance to default in 2009.
In fact, defaults have been roughly half that so far. That’s still a post-war record, and the year isn’t over. However, defaults are now slowing. So it seems the worst fears, while understandable, were wildly overblown. They led, though, to giveaway prices, even taking into account giant spreads of 30 points or more. The Standard Chartered issue I bought at £67 per £100 nominal, has a running yield of 12 per cent, and the Aviva bond was bought at an incredible £38 per £100, with a running yielding of 15.8 per cent. I was even able to go back a few days later and load up a great deal more at £37. Those kind of once-in-a-lifetime prices demand a courageous response.
Today, the Standard Chartered preferred stock is trading at £111, up 67 per cent, and the Aviva issue has more than doubled to £79. Having already received this year’s income, this brings the total return in six months on the Aviva bond to 125 per cent, and makes it my largest holding. This high octane performance, I have to remind myself, is from a bond, not some risky share!
I looked for further bargains over the summer. None was quite as good as this, and the spreads were awful. Even so, I found Enterprise Inns’ 6.5 per cent 2018 with a yield of 9.15 per cent, and then a host of enticing permanent interest bearing shares (Pibs) issued by building societies.
Pibs had long been a sleepy subsector of the market, often (mistakenly) used by savers looking for a high safe income rather than by investors. This supposed safety – already knocked in 2008 by the travails of former building societies such as Northern Rock and Bradford & Bingley – was shattered this year by the difficulties of a few high-profile societies, such as West Bromwich, Chelsea and Dunfermline. A mass exit by the risk-averse holders created huge losses for them, but giveaway prices for others.
To assess the potential, you have to be prepared to read building society annual reports and bond prospectuses – and judge which should be avoided and which risks taken on.
Pibs are perpetuals, and therefore don’t have to be redeemed, but they can be called at specific dates at the issuer’s option. Consequently, there is a chance for a yield to redemption which, in almost all cases, is well into the teen percentages.
So I decided to spread my investment over a number of Pibs, from the safest to those with moderate risk.
At the safe end, I identified Nationwide Building Society Pibs and the perpetual subordinated bonds issued by Co-op Bank when it took over the Britannia Building Society. These were available for about 65-70 per cent of face value, and yielded more than 8 per cent.
At the riskier end, I looked at Principality Building Society and Kent Reliance, both very small, and not without their difficulties. I got Principality’s 7 per cent 2020 Pibs for £55 per £100, with a running yield of 12 per cent. Kent Reliance’s Pibs, which I didn’t purchase until the end of September, cost me £72 with a running yield of 9.15 per cent.
This bond portfolio, now 21 per cent of my total portfolio, yielded 11.3 per cent at purchase. In times of minimal inflation, I regard that as a pretty good income.
Nick Louth is an active private investor, writing about his own investments. He may have a financial interest in any of companies, securities and trading strategies mentioned.
