If you invest in high yield bonds, it is not difficult to get interest twice or three times the deposit rate. It is enough to choose the securities of companies that will not go bankrupt.
READ IN THE ARTICLE:
✔ What is high yield?
✔ High yield in Russian
✔ The question of risks
✔ Choosing a paper in a portfolio
✔ Studying documents
✔ How to buy high yield?
What is high yield?
High yield bonds, or high yields, are securities of companies without a credit rating or with a credit rating below investment grade. Usually we are talking about representatives of small and medium-sized businesses. Such businesses need to offer investors a high rate to raise funds.
Around the world, bond ratings are a defining indicator for investors. Basically, it is an assessment of the creditworthiness of a company or any other borrower. The concept of “investment rating” refers primarily to the three leading international agencies – Fitch, Moody’s, S&P. They are the ones who assign most of the ratings in the world. Their ratings are letter-labeled (eg AAA, B, CC) and reflect the strength of the bond. AAA is the highest degree of reliability. Bonds with a rating below BBB- are considered high risk in the world, this is a rating below investment grade. However, Russia has its own rating scale. The ratings for domestic companies are assigned by ACRA and Expert RA agencies, and the main sign of high yield is the lack of a rating as such.
In the West, such a segment of the debt market as high yield is very developed. Its share in the United States reaches 18% of the total corporate bond market. The high yield category includes high-yield bonds of small and medium-sized companies. Such issuers are also called “rising stars”. There is another high yield category. These are bonds of large companies, whose financial position has deteriorated, as a result of which they have lost their investment rating, and the yield on their bonds has grown sharply. In American terminology, they are called “fallen angels”. We will not talk about the papers of the second category in this article, but will dwell on the “rising stars” in more detail.
The more nervous the situation in the economy, the higher the high yield. The maximum yield on such securities was reached in the United States in 2008 at the height of the international financial crisis. At that time, US Treasury bonds were traded at a yield of 3-4%, while a high yield could earn 25-26%. Now similar bonds are traded with a yield of 5-5.5%.
Fig. 1 Share of high yield bonds in the US debt market.
In Russia, the “rising star” market has existed for only a few years. Before, such issuers did not even try to place bonds. However, after the Bank of Russia greatly tightened the requirements for loans to small and medium-sized businesses, it became much more difficult for them to obtain financing from the bank. Small businesses started looking for alternative sources. By that time, the stock market had an infrastructure for the placement of bonds of such companies. In addition, individual investors entered the public debt market en masse in search of higher yields than deposit rates.
On high-yield bonds of Russian issuers, you can earn from 16 to 23% per annum. The rules of classic investment in high yield assume that the portfolio should contain 20 securities of different companies with different maturities.
“Then, in the event of a default by an individual issuer, you will not“ collapse ”, and the remaining portfolio will still allow you to have higher returns than in the case of investments only in the first echelon,” explained Denis Kozlov, Managing Director of Septem Capital Investment Company.
In America, where there are hundreds of such companies, such a strategy is easy to implement. However, now there are only 10-12 of these issuers on the Russian debt market.
Denis Kozlov is sure that in several years the volume of the Russian high-yield bond market will grow significantly: “If at least every 15th representative of small and medium-sized businesses is brought to the public market, then we will talk about bonded loans totaling about 600 billion rubles. yearly”. However, so far the entire volume of Russian high yield does not exceed 2 billion rubles, so it is necessary to carefully assess the risks of each candidate for inclusion in the portfolio.
Tab. 1 Range of high yield bond rates in the Russian market with the forecast of IC “Septem Capital”
There is still not enough statistics on our market to assess the risks of default by an issuer from the high-yield bond segment.
We can only refer to the history of the American market. And according to colleagues overseas, the share of defaults on bonds of issuers from the high yield category varies from 0.5% to 12% per year.
The maximum result of about 12% was recorded in 2009, when a crisis of confidence erupted after the collapse of one of the largest investment banks Lehman Brothers in the country. Banks, just in case, closed the limits for most counterparties. It has become simply impossible to refinance bank loans and bond issues. However, after this record year and to this day, the percentage of defaults has not exceeded 4% per year.
In recent years, this figure has been declining in the United States along with rates on high yield bonds. Denis Kozlov believes that the Russian high yield market repeats the history of the American one.
“If we look at the 70s in the USA, then with the yield of American Treasury bonds at the level of 8%, high yield showed a yield of 16-17%. What is happening with this segment in Russia now largely repeats the situation in the United States. Our government bonds show a yield of about 7%, a 16-19% yield on a high yield, ”the expert explains.
Fig. 2 Graph of the ratio of high yield bonds to the percentage of defaults in the United States
Choosing paper for a portfolio
Despite the fact that the Russian companies that have placed bonds in the high yield segment can be counted on one hand, they represent a wide variety of industries. This is a cargo carrier, a shawermen chain, a pawnshop, microfinance companies, and leasing companies.
The risk of such investments is difficult to assess, since none of the issuers has gone bankrupt yet. However, experts believe that there are candidates who can default on their securities in the foreseeable future. How do you make the right choice?
Each bond issue has an organizer company that places it. He is attracted in order to determine the level of the rate at which investors will buy the company’s bonds. They are also looking for potential buyers of securities. Debt market experts advise looking at the issuer first. Its name is easy to find in the announcements of the placement.
It is worth looking through Yandex or specialized portals like rusbonds.ru and cbonds.ru, who has this company already placed before? Were there among her clients those who later defaulted on securities? If so, this is a bad signal. The organizer must have an unblemished reputation, because it is he who is the first to assess the credit quality of the future borrower.
It is necessary to draw the attention of the owners of the company. “If a trail of bankruptcies of other companies follows the owner, it is better not to get involved with his new projects,” explains Denis Kozlov.
Check out company reviews and executive interviews. After that, you can proceed to study the documents accompanying the placement – first of all, we are talking about an information memorandum.
A company entering the debt market must have a cash flow. Look at the dynamics of revenue for at least 2 years. It is better not to get involved with startups that do not yet have any metrics. Submit their perspectives to professional venture capitalists.
Calculate whether the company’s net profit will be enough to service the bonds. Look at the ratio of debt to EBITDA (earnings before taxes, interest and amortization). The first should not exceed the second by more than three times. In addition, ideally EBITDA should be double the debt service interest payments.
Another important point is the presence of covenants. Covenants are additional conditions, upon reaching which investors have the right to demand early redemption of bonds. This helps to minimize risks. Standard covenants usually relate to a change in the ownership of a company, cross-default, that is, default on other issues, an increase in the debt burden, violation of the terms of information disclosure, and the use of borrowed funds for other purposes.
How to buy high yield?
You can find out about plans to place new issuers on the website of the Moscow Exchange, as well as the specialized agencies rusbonds.ru and cbonds.ru. In addition, in the open spaces of the Russian Internet there are several specialized forums where investors discuss interesting issuers.
High-yield bonds can be purchased either at the initial placement stage by contacting the placement organizer, or on the secondary market.
High yield bonds are presented in the form of commercial bonds and exchange-traded bonds. Commercial bonds are not traded on the stock exchange, so their purchase is possible only through the placement organizer. Exchange-traded bonds are freely traded on the stock exchange, it is easier to buy and sell them, but the yield of such securities is lower.
According to the requirements of the Moscow Exchange, the minimum lot for the initial placement of exchange-traded bonds is 4 million rubles. In the secondary market, that is, when the bonds have already been placed and entered the free sale, you can purchase securities for an amount of 1,000 rubles or more.