Low Risk - 5% or more return?

bowlhead99

brendon wrote: »

This isn't correct. Barclays have a call option to buy back in 2017, but they may decide not to. Then they will start to pay 3 month LIBOR + 1.42%, which is currently 1.58%. See http://www.fixedincomeinvestor.co.uk/sdoc/3558.pdf

That's true. Back in mid 2005 when the prefs were issued, Libor was a little below 5%.

However, Mark Carney has suggested in recent months that base interest rates will rise only slowly, to a new long term normal that is more likely to be something like 2.5% (mentioned in a radio interview) rather than some of the high rates of old.

So if we get there by end of 2017, Barclays would be looking at paying only 2.5 plus however much 3mth Libor exceeds Base, plus 1.42. So, maybe 4ish percent total. If rates do not rise as fast as that (i.e. don't go up 2% in three-ish years) then they would be paying even less.

Given Barclays are currently paying a running yield of 6% on these prefs, while base rates are on the floor, one would assume that if the risk free base rate goes up by 5x, they would not be able to refinance onto a new issue of prefs or other instruments at only 4%. So, they would choose not redeem them.

Then if you look at what the investors are looking for, in a higher interest rate environment (i.e., if everyone thinks Barclays should not be able to get away with only paying 4% on their prefs, and wants more) - the market price of the prefs would have to drop to a new lower value at a significant discount to par. If I as a prospective investor in 2017 want to get a running libor linked yield of 6%+, I would not pay £10,000 for the share that only pays £400 a year. I might perhaps pay you £6,666 to buy your share, because that would hit my yield target. That could be somewhat expensive for the chap who bought in at £10,400 this year and was kinda hoping Barclays would just redeem them at £10,000.

The loss is probably a bit exaggerated there because if I know Barclays would potentially redeem at £10,000 if rates went high, my expected yield would be better than my mathematical running yield, and if the discount was massive you would find people (if not Barclays themselves) looking to buy it up. But it's still a risk.

Clearly if interest rates do go up from here and become stable and the economy recovers nicely then banks may benefit and Barclays may be stronger than they are today, and everyone may become much happier to accept only 4% linked to Libor for a preference share that only pays out in the years that Barclays can afford it. So you would not necessarily lose so much capital, and/or Barclays might just redeem them and replace with super-cheap finance from somewhere else willing to provide it on the back of Barclays's newfound financial strength.

However, this is in the realms of speculation - all a bit of an unknown and there are no certainties when investing in shares, even those that intend to pay a fixed return.

If a share or a bond may be redeemed at the option of the issuer after a particular point, you should certainly work out your returns as if they do just that. But you should also work out your returns as if they do not choose to do that. And then you have the range of returns that you might make, and you can periodically estimate where in the middle you're likely to end up based on your view of the economy and the market conditions and the company's status and what they might do.

bowlhead99

coyrls wrote: »

OK I understand, but although there are short term bond funds, in the event of a significant outflow, they would have to sell the bonds prior to maturity to fund payments to those who were selling.

Yes, holding through any kind of fund gives you a different risk profile to holding the underlying instruments yourself.

If you and I and 8 others each put £1000 into a fund which bought £10,000 of investments and then you want to get your tenth of the fund out quickly at an in-opportune time, and the holdings are not very liquid, we might have to sell about £1000 cost-worth of units at a fire-sale price and only get 90p in the pound for them. So the fund makes a realised loss of 10% on that tenth of the overall portfolio - a 1% loss overall. Even when the price returns to 100p later in the year, we've taken an actual loss of £100 at the fund level. So you and I and the other 8 people all lost £10 each (1%) as a result of you wanting to jump off at the bottom. Thanks

While if it were me holding the bonds directly, I wouldn't care that you want to exit your position. I would keep holding my own bonds to maturity and not lose the 1%, getting my £1000 back as expected.

Of course in reality, with only £1000 to invest, I could only really buy one or two bonds out of the thousands out there. I might have to pay a tenner transaction cost to buy and sell each of them which is a greater cost than buying and selling the fund, and if one of them goes bust I have lost half my capital. So, it's not necessarily a safer or cheaper way to go at all.

The reality is that if you are looking at a fund that only has short dated bonds which are inherently less volatile than long dated bonds, they are less likely to suffer a 'run' or a liquidity crunch because the prices should not fluctuate so much.

Example, if a bond priced at 99.8 is going to pay out at 100 in a couple of months time, and the fund manager needs to sell it to collect together enough cash for someone's redemption payment, he is not going to have trouble selling even large quantities of it in the market. Clearly such a bond is not risk free but the buyers will appreciate that it has a high probablility of paying out relatively soon and it is almost as 'good as cash'.

Whereas a fixed interest coupon for the next 20 years where the company has plenty of time to go bust and the market interest rate might quintuple over the two decades for all you know, is a much harder sell, relatively - and if the whole market is getting nervous about interest rate movements and looking to get out of fixed rate bonds at the same time you are, you might have a liquidity problem.

Reaper

brendon wrote: »

This isn't correct. Barclays have a call option to buy back in 2017, but they may decide not to. Then they will start to pay 3 month LIBOR + 1.42%, which is currently 1.58%. See http://www.fixedincomeinvestor.co.uk/sdoc/3558.pdf

Thanks for that, I had indeed missed that important detail. It just goes to show you always need to read the prospectus rather than depend on tables. It adds uncertainty into the mix trying to guess what might happen on the call date, making them less appealing.

Thrugelmir wrote: »

Companies can also suspend dividends on preference shares.

They can though they are not allowed to pay any dividends to ordinary shareholders until they start paying preference shareholders again. In the past banks have proved quite determined to pay preference shares even when in difficulties as far as the rules permitted. Lloyds even invented a new financial product (ECN) and allowed preference shares holders to convert to them as a way of getting round EU rules and continue paying out. I didn't mention it as it was already covered in the earlier thread along with more info.

jamesd

An interesting looking peer to peer option is Ablrate. Relatively new but the loans are secured on aircraft or other things. There's a very well established leasing market for aircraft and the loans are mainly to fund the initial purchase of regional planes for that market.

It isn't low risk but it is low volatility and should be quite reasonable on the overall risk side.

Steve_xx

Roland_Flagg wrote: »

As for Reg Savers, I have a few of those, but the yearly interest rate works about half because of the drip-feeding.

That's not correct to say. The yearly interest is as stated on these accounts, ie if it says 5% interest then that's what you get for the amount of time that you have your money in there. Though I agree that due to drip-feeding that you would not earn as much over a year than if you had been allowed to put all of your cash in at the start of the term. Nevertheless the interest rate is not halved!

lozzy1965

There are half a dozen or so, FTSE100 companies currently paying 5%+ dividends. I regard top 100 companies, over a 5 year period, as relatively low risk. All things being equal, you should see some capital rise, plus the dividends. Usual stock market warnings apply.

bowlhead99

True but often the ones that appear to be paying higher percentage dividends can turn out to not be sustainable in the long term. Take Morrisons for example, if they cut the dividend to reflect their declining profit that will not be great news for you getting a continuing 5% on your original investment, nor for your capital position until they hopefully get back on track in the future.

So, as you say, normal stock market warnings apply. Selection of stocks (and some would say a good dose of luck) is key. The total value of an investment in the FTSE 100 (i.e. total return including dividends) in December 1999 had declined 30% by the bottom of the credit crunch in March 2009. The dividends are very handy because the pure index value had fallen 50% (!)

So, whether you are looking at 1.5 years from Oct '07 or the 2.25 years from Dec 1999 or the 9.25 years from Dec 1999 there can be some intimidating losses on a basket weighted to the largest and most 'blue chip' FTSE stocks and you have to be able to hang on during the years that follow to wait for a recovery. With a smaller basket of stocks personally cherry picked, you are less likely to get the 'average' loss but you could do even worse.

Or you have to be able to avoid the stocks that don't hold their value. If you had picked a nice high yielding dividend-paying stock like Lloyds Banking Group in 2007/8, you might have been somewhat disappointed to see the price go from 500p to 20p.

geoffky

Another person looking for a home after spending the last five years getting 5% at the Newcastle bs..But it is a large amount and juggling these 4% accounts just will not put a dent into it..So i have parked it..For now..

mike88

Google PIBS and PSBs. These are emphatically not a recommendation but will provide the degree of income required. The risks need to be understood before buying.

Reaper

mike88 wrote: »

Google PIBS and PSBs. These are emphatically not a recommendation but will provide the degree of income required. The risks need to be understood before buying.

One of the risks is I don't get the feeling banks seem to feel a moral obligation to honour PIBS. Probably because unlike preference shares they have no effect on the ordinary shares. One of the worst examples was Bristol & West PIBS, taken over by Bank of Ireland. For those aware of the famous "prisoners dilemma" logic puzzle it was a fascinating example of the theoretical puzzle used in real life. To push it through they said holders had to agree to lose 80% of their money. If the majority voted in favour then any who had voted against would get nothing. The plan was that desperate small investors would hope everybody would vote No but they themselves would vote Yes (after all their holding was surely too small to make a difference to the outcome) so if the worst happened at least they got 20% of their money back. Of course when everybody else does the same it gets passed even though nobody wanted it. The plan was brilliant and repugnant at the same time.

Fortunately a campaign by this web site was instrumental in getting it called off after a big struggle.
http://www.fixedincomeinvestments.org.uk/home/bank-of-ireland-13-375-subordinated-bonds