Investors reminded of dangers of investing in perpetual bonds
On Tuesday, investors were reminded of the dangers of investing in perpetual bonds at a time record low interest rates as Indian conglomerate Reliance Industries (Baa2/BBB) sold a senior perpetual dollar-denominated that offered very few guarantees that the principal will ever be repaid.
Even as several fund managers and credit analysts warned of the lack of protection to creditors, the company was able to sell an US$800m perpetual at 5.875%, the tightest an Asian company has achieved on a senior secured perp. That yield was still some 50bp higher than what the company's 2040s were offering in secondary markets.
However, savvier investors, such as fund managers, stayed away from the transaction, which was mostly sold to private banking accounts, traditionally considered less sophisticated.
On their first day of trading, the bonds traded as low as 96.35 after pricing at 100.00, making for one of the worst performances for an Asian dollar investment-grade bond this year.
The reason for the drop, according to fund managers, was the bond's very weak structure. "If they fail to call the bonds in the fifth year and 30-year US Treasury yields go to 5%, the yield on these bonds would go to 8%," said one portfolio manager.
The problem is basically on the call, or when the company is allowed to buy back the bonds. Investors in perpetual bonds often assume that the bonds will be redeemed on their first call date, which in Reliance's case is in 2018. However, from the company's standpoint, it only makes sense to buy
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