Business

Undervalued bonds = profit opportunity

BY DENNISE WILLIAMS
Contributor

Friday, September 29, 2017

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Jamaican investors may be shying away from bonds due to concerns of rising interest rates asa a result of United States Federal Reserve actions in recent months. However, there is money to be made where investors consider, with the help of their licensed advisor, undervalued bonds that can profit within the context of interest rate uncertainties.

Adrian Smith, securities trader at Stocks & Securities Ltd, noted that, “For all investors who currently have bonds in their portfolio's should be aware that with the Federal Reserve increasing interest rates, the bond prices have gone down due to the inverse relationship with interest rates and price.”

So in some cases bond prices have gone down, yet. Smith notes, “This is a non-issue if you were planning to hold your bonds till maturity because you will still be receiving your coupon payments on time, and at maturity, outside of default, you will get back your principal. In their near future, to take advantage of the lower prices, savvy investors will find investment-grade bonds which have seen a drop in price, while giving an attractive yield, and has a shorter period of time to maturity, and invest accordingly.”

The key to profit in this market is to understand exactly what is an undervalued bond.

Smith explains, “The term 'undervalued,' when used in the financial industry, tends to speak to the price of a security which is quoted below its investment intrinsic value.” Essentially you want to buy a bond at a price that is lower than the value of the company that is backing the bond. A big opportunity for bond value hunters, according to Smith, is the telecommunications industry.

“Taking at look a bond being offered by AT&T (AT&T 4.5 per cent 2035). This bond is currently trading at discount value of $98.50. AT&T INC (NYSE:T), has improved earnings per share by 14.5 per cent in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently, but it is poised for EPS (earning per share) growth in the coming year.”

That means that the bond should be selling for $100 or more and you are getting it at $98.50, which offers an immediate $1.50 savings. Plus, the earnings have grown by 14.5 per cent in 12 months.

According to Smith, investors could receive a return of about 4.59 per cent per year on US dollars and could be considered undervalued. And with savings rates in the region of 1 per cent or less, this could be a vaiable option for individuals who are comfortable with bonds.

US-based fixed-income trader Scott Mather notes that investors can consider five core areas for bonds. He writes in Pimco.com, “Here are five specific areas where we see value:

1. US agency mortgages backed by housing debt issued through the federal government.

2. Inflation pressures could gain momentum over the medium term, so we think TIPS (Treasury Inflation-Protected Securities) offer attractively priced hedges against the possibility that inflation.

3. Financials. As equity markets have set all-time highs over the past several months, we see opportunities in select sectors, particularly financials, where balance sheets are generally healthy.

4. Non-agency mortgages. It may seem strange to advocate US government bonds when yields are at historical lows, but there is value beyond yield hunting.

5. US treasuries are one of the most liquid, high-quality ways to diversify and potentially provide the negative correlation to most risk assets that investors seek in core bonds.

Bottom line is that Jamaican investors with a risk appetite for US-based securities can earn attractive returns. Smith does make one closing note, “ Before purchasing any bond, knowing about the company or country (sovereign bonds) is highly recommended.”

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