bonds

All posts tagged bonds

A UK-based chocolate manufacturer, Hotel Chocolat, has come up with a novel way to raise capital for expansion. Instead of borrowing money from banks or issuing regular corporate debt, it has decided to raise about $7.5 million USD by issuing “chocolate bonds“. Instead of a regular dividend payment (well technically it’s a coupon payment and not a dividend), these bonds will pay dividends in chocolates!

hotel-chocolat-box-of-chocolates

In order to be eligible, you need to be a member of their “Tasting Club”, which already has 100,000 members. For an investment of $2,890 USD or $5,760 USD, you can get a juicy annual dividend of 6.72% or 7.29% delivered to your doorstep every other month.

If you’ve ever been to high-end confectionery, you’ll know they charge a couple of dollars for each piece of candy.  So spending a few thousand quid might not be such a bad investment. Especially since bank yields aren’t very impressive right now. At least it guarantees you won’t have to spring for chocolate for three years, even if the rest of your portfolio tanks!

I wouldn’t be surprised a chain of British gyms are next in line to offer special “weight-loss bonds”, with special dividend rates for people who bought the chocolate bonds!

But the real question is whether Inland Revenue will be accepting their tax payment in chocolate too?

Almost exactly a year ago, I mentioned a paired-trade investment between the long-term Bond ETF (TLT) and short-term corporate/sovereign bond ETF (AWF).  I went long AWF and shorted an equal dollar amount of TLT. Last week, I closed the position after holding it for just over a year.

When I entered the trade, AWF was trading for $8.29 and had a yield of 13.4%, while my short position in TLT was trading at $112.10 and had a yield of 3.5%.  When I close out my position a year later, AWF had a price of $13.10 and a yield of 8.6%, while TLT was going for $91.65 and yielding 3.9%.

I made about 63% on the long AWF position and 18% on the short TLT position. Coupled with the 9.9% net dividend yield, that trade made me ~91%. Not a bad return for a year and 4 days.  Bond yields don’t usually move 500 basis points in a year. No point being greedy. Time to bank some profit!

paired-trade-awf-tlt-returns

A drop in the stock market will cause the price of bonds to move up, since they typically are inversely correlated. Similarly a sharp rise in in yields would cause bonds price to drop. I expect a move in TLT to about roughly $96 at which point I might renter the position depending on the larger macro-economic picture.

In a previous post on Deleveraging, I promised I’d talk about an interesting long-short bond trade that I entered last week.

If you believe that US Treasuries are over-valued, or foreigners will lose their appetite for US debt thus forcing up the interest rates, you’re probably looking to short treasuries.  Ok, maybe you haven’t looked in to shorting anything.  In that case, may be you should read this link on Barrons and then come back. (Barron’s thinks that investors are buying gold as an alternative to near-zero yielding treasuries.)

One of the ways to short the Treasuries is buying the UltraShort Lehman 20+ Treasury ProShares (TBT).  This ETF returns twice the inverse of the daily movement in the 20 year T-bill. However, these things never move in a straight line and can be extremely volatile.

Instead, I decided to do something a little esoteric.

I shorted the iShares Barclays 20+ Year Treasury Bond (TLT) and netted $112.10 per share.  I used that money to buy an equivalent dollar amount  of the Alliance Bernstein Global High Income Fund, Inc. (AWF) at $8.29 (that’s buying about 13.52 shares of AWF for every share shorted of TLT).  Unlike the TBT position however, this position yields a dividend! AWF has a yield of ~13.4% while the short TLT position had a negative yield of 3.5% (since I shorted the ETF I need to pay this dividend), which results in a positive net dividend yield of ~9.9%.

Since TLT and AWF might sometimes move in sync, you’d think this portfolio would have a lower volatility than just TBT. Just to be sure, I also calculated the standard deviation of this portfolio on a bloomberg terminal at school and the resulting standard deviation was about 30% lower than for each individual ETF. (The standard deviation is often used by investors to measure the risk of a stock or a stock portfolio. The basic idea is that the standard deviation is a measure of volatility: the more a stock’s returns vary from the stock’s average return, the more volatile the stock. In short, less volatility is better).

Check out the graphs of TLT, AWF and TBT. Remember, TLT is a short position so you need to multiply the returns by -1 and add it to AWF.

long corporate bonds - short US treasuries

From the chart you can see that yesterday both TLT and AWF trended higher and predictably TBT lost value.  However the combined portfolio was slightly positive.

After last years volatile returns, anything that reduces volatility in your portfolio is a good thing!

Note that AWF is mainly comprised of short-term US corporate debt and some soverign bonds. There is a some foreign currency risk involved but with the US Dollar being a lot higher than it was a year ago, I’m willing to take this risk.

[Disclaimer: In case it wasn’t obvious, I’m long AWF (short-term corporate bonds) and short TLT (long-term government bonds).]

In my last post, I mentioned that about California was running out of cash.  Because of these concerns, yields on California Municipal Bonds are pretty high right now. But is it safe to buy them?

According to the Wall Street Journal, it would appear that it is. They asked the California state treasurer Bill Lockyer whether  the California public debt was completely safe. “Absolutely, the only way we’re going to default is if there’s a thermonuclear war.”

David Blair, the head of municipal credit research at bond giant Pimco, agrees. “They clearly have the ability to pay,” he said. But he added that the main risk is headline risk, where bad news smacks prices.

The ten-year Treasurys currently yield about 2.5%. California’s bonds yield about 4.2%. And that’s also exempt from federal income tax.

According to Vanguard’s Mr. Smith, the gap between the two has never been so high. The picture is similar for municipals across the country. Panicked investors have dumped everything – and blindly jumped into Treasurys, driving yields down to incredibly low levels. Meanwhile munis are also under pressure because so many states and cities will have to borrow more.

So there’s no doubt that California will pay back the debt. In the worst case, the Federal Reserve would just bail the state out. If they’re willing to bail out car companies, I’m sure they’ll step in for California.

But if there’s more bad news, the yields could go higher still, and the prices of the bonds could fall in value.