Familiar Name Not Familiar Risk


Familiar names offer a false sense of security

Common investing mistake number 2: Familiar names are low risk. Just because you are familiar with the name of the company and it’s business line, does not mean that bonds issued by the company are “low risk”.

A good example is Barbados. The island lost its investment grade credit rating in 2012 and was downgraded on multiple subsequent occasions. By 2017 it had a CCC+ rating and investors could have still sold their bonds in the 90’s or 80’s (Depending on the specific bond and time of year) Investors often think that if they are selling a bond below the purchase price, then they have lost money. This is not necessarily so. One must account for the coupon payments earned throughout the time that the investor has held the bond. This is akin to calculating the return on a stock without including dividend payments or calculating the return on a property sale without including the rental income you earned during the ownership period. Investment advisors should calculate a more accurate holding period return to help their clients make their entry and exit decisions. After the new government declared default in 2018, the bonds fell to below 50 cents on the dollar.

Another famous example popular among local investors was Venezuela. The country’s vast oil resources, high bond yields and the “buy” recommendations from local brokers, prompted investors to ignore the political risk and allocate far too large a percentage of their holdings to this risky debt.

On the local market, investors are willing to accept lower rates from corporations they are familiar with than safer corporations they are not familiar with. Investors could get higher or comparable yields in the global market for the same risk level. For example, 2 recently issued local bonds offered yields ranging between 9% and 11%. However, investors could have gotten similar yields on global bonds with similar or lower risk and better liquidity.

It is important to note that when local companies issue bonds, they would, at best, have a credit rating equivalent to Jamaica’s B3 (by Moody’s) or B+ by S&P. According to Moody’s, obligations rated B are considered speculative and are subject to high credit risk. According to S&P , “An obligation rated 'B' is more vulnerable to nonpayment than obligations rated 'BB', but the obligor currently has the capacity to meet its financial commitments on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments on the obligation”. Lesson: compare the local bond you are buying to a B rated issuer on the global market, to make sure you are being adequately compensated for the risk.

Bonds traded on the global market can always be sold with ease and funds received within 2 days. Locally issued bonds are much more difficult to exit because the market is minute in comparison and local trading platforms are not as well developed. Investors should be aware that it is possible to get comparable yields on bonds of lower risk and with more liquidity on the global market. Instead of using familiarity of the name as a metric for safety, consider instead the underlying creditworthiness of the issuer.

Important Resources

Understanding Bonds

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Biggest Investing Mistakes Right Now

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How Mutual Funds Work

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