Have you heard about new bonds coming to market? Probably not, but it’s something I feel you should know about. Typically, the financial news covers topics like new Initial Public Offerings of stocks (IPOs) like the ones from Snapchat, Alibaba, and Visa.
New bonds coming to market, however, are often left ignored. The good news is that this can be more consequential and to your advantage, because it allows active managers the potential to pursue alpha. (excess return vs a benchmark)
Let’s take a look at how.
The Impact of New Bonds
New bonds coming to market create a noticeable impact for active managers for many reasons:
- These new bonds come to the market more frequently and take up a much bigger piece of the market. According to Barclays Point, just over these last three years, new bonds have made up more than 20% of the market capitalization in the U.S. corporate bond market. Equity IPOs, on the other hand, came in at less than 1% of market capitalization over that same time period, according SIFMA and Bloomberg. This is largely because bonds have finite maturities as opposed to the never-ending nature of securities offered through IPOs.
- New bonds are a source of potential. Managers who deal in active bonds usually buy them right when they come to market, and this can be a week or more before securities come into the index at the beginning of the month. This is important to keep in mind because the new bonds come in at a slight discount to outstanding issues. This is known as the new issue concession. 1
Passive managers wait to buy, but they run the risk of tracking errors if the prices change before the bonds join the index. They can also be faced with limits when it comes to off-index exposure and how much they can hold. This is because passive managers try to replicate and match the index rather than beat it outright.
- Active managers are able to pick and choose what they buy. While many new bonds come with a concession, active managers don’t always buy them. Firms, like PIMCO and others with credit research teams, might pass on a purchase if they think it’s overpriced. Passive managers, on the other hand, have incentive to buy no matter what.
All About Size
The larger a manager is, the more of an advantage it has in accessing new bonds, especially when it comes to larger deals. Investment banks will often create distribution syndicates when they have billions of dollars worth of bonds to sell. An individual running a syndicate desk may rely on a small pool or investors who have a lot of money in order to obtain orders and guarantee theres enough interest to move ahead with a new bond issue before rates go up. Think about Verizon and its issuance of $49 billion worth of bonds in 2013.
It wanted to use the money to finance the acquisition of Vodafone’s remaining stake in Verizon Wireless. With the issue being that size, Verizon offered a spread concession of 50-80 basis points. This was a lot higher than the typical investment-grade new issued concession of 10-20 basis points. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument. According to Bloomberg, the 10 largest buyers received 45% of the offering, with the top five acquiring about a third of it.
Newly-issued bonds play a larger role in fixed income markets than IPOs do in stock markets. While getting access can be competitive and not every manager has a portfolio large enough to absorb large amounts of new issues easily. Not all big deals are attractive, and it’s important to know which ones to pass on.
If you want to know more about bond issuances and how they can factor into your retirement plans, feel free to get in touch with me today.
1. The difference between what the public pays for the securities and what the issuing company receives from the sale.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. All investing involves risk including loss of principal.