professionals), to see if there is anything interesting on offer, and I check for prices or news on bonds I am following. Another good source of ideas is to ask, when I ring up a trader to close a trade, if there is anything else he particularly thinks is a good idea or if he has something illiquid on his books he doesn’t want that is going cheap. It is always good to keep probing, not because the traders are trying to hide anything but because frequently people forget what they have on their books or erroneously assume you will not be interested, so don’t mention it.
Then, particularly if the security I am looking at is a financial sector bond, I will tend to read or at least skip through the prospectus. It is very important to work out if and under what circumstances a bond can stop paying interest without going into default. Are there any other nasty clauses that could get you? Forcible equity conversions or write downs under certain circumstances, for instance. Even though you may know the category of debt into which a given bond falls you have to look at the small print. Generally older issues are more kind to investors.
I then also consult the news to see if there is anything relevant to do with the issuer. Sometimes you are investing in the eye of the storm where you have to accept there are plenty of unknowns and a fair degree of random outcome but it may be alright on the night. Other times it is an old story or problem and in this case you have more time to consider and there will fewer guesses to make. Investing in speculative-grade bonds can be as much an art as a science and you have to try and work out what will happen if things go pear-shaped – i.e. will bond holders lose money? Is it the sort of corporate with a good business which will be recapitalised by shareholders without pain to bond holders or what degree of government support could there be? Can you trust the government to play fair (probably not if they can help it)? Or will there been some sort of arbitrary, inequitable and retrospective outcome as they choose to over-rule the prospectus you have spent so much time combing through? On the one hand if the authorities are in trouble you may well be too as they seek to play to the public gallery. But, on the other hand the bond market is collectively very powerful and the government have to make sure they don’t bring the house tumbling down on their heads if they lose all trust.
Sometimes there are opportunities when the bond has already gone over the edge and into default. As long as the expected recovery is greater than the current price you can be on to a winner. Also could there be a debt for equity swap? It can be good if you enter at the right moment. For example, British Nuclear Energy went bust, bonds traded down to 25%, there was a debt for equity swap and the price zoomed up to 200%. For this it is best to get hold of an analyst at an investment bank who has gone through the story in detail. For these types of situations the analyst, and it can involve leg work to track down the right person, is the person you want to speak to and will know much more than the trader who is really only there to trade the flows. Research having been done, occasionally you ask a trader why a bond is trading so cheaply and you get the answer “Don’t ask me mate! That is just where I got hit by someone clearing out an old position.” Then you know the odds are in your favour – he makes a turn but you have superior information.
And then it is on to the phones.”
Investors
There are probably just two types of investor in the equity markets: funds and private investors. The world of bonds has many more types of end user, all of whom may have marginally different reasons for buying a bond. Below is a list of the various types of fixed income investors that I have encountered over my years in bond sales:
Table 3.2: classification of investors in bonds
Endnote
1 Often attributed to Charles Dickens’ Mr Micawber, who should have heeded it. [return to text]
Chapter 4: The life cycle of a bond
The timeline of a new issue
Corporates and other bodies have funding programs, dictated by both their future capital requirements and the need to roll or re-finance expiring and maturing sources of funding. With this in mind, chief financial officers (CFOs) will be constantly in touch with the primary issuance, or debt origination, departments of investment banks.
The CFO’s primary duty is to obtain the funding the business needs, with the right maturity profile and at the right price. In addition to this, a good CFO will consider factors such as funding diversity, in order to make sure that the company is not over-reliant on one type of investor.
The bond market, and its participants, operates internationally. Frequently, a UK borrower will opt to issue into non-sterling markets if there is sufficient price advantage, swapping the proceeds back into its own base currency to match assets against liability. The same is true for the sterling markets, overseas operators will issue bonds denominated in pounds as and when the price is right – this will be influenced by numerous complex factors including local interest rates and yield curves, the degree of domestic demand for the individual credit and the complex and ever-changing market of cross-currency interest rate and basis swaps.
The lead managers and the selling group
Turning to the gilt market first, new issues are handled by the government’s Debt Management Office (DMO). There is a straightforward issuance procedure for gilts where the market makers and members of the approved group may bid for the new bonds and auctions are held on a scheduled basis with the calendar determined just after the budget in March.
The process of launching new corporate bonds is somewhat different. A Eurosterling corporate bond will usually be launched through the route of a lead manager (usually a large investment bank) and one or more co-leads,co-managers or syndicate members. The lead manager will take on most of the risk and the workload of bringing the new issue to market. The co-managers and syndicate members will help ensure that the bond is distributed across a wide range of investors, and also provide a buffer of liquidity in the first days or weeks of the distribution process with syndicate members taking the bonds onto their own books for a few days or weeks to smooth the process of selling large blocks of bonds to investors.
Primary issuance is a profitable business for investment banks. The fees charged by the various members of the issuance syndicate vary, but a UK corporate might pay 0.35-0.45p in the pound to issue a ten year bond. Retail-targeted bonds are typically smaller in size and thus fees will be higher in percentage terms. Here the fees may be around 1% of the total (and in some cases higher). These fees will be shared with a distributing group of brokers, with 0.25%-0.5% being a typical distribution.
Above and beyond these fees will be the profit (or loss) booked on the trading books during the syndication process. This will be a factor of the bank’s decisions in selecting the right issues to participate in and the skills of the trader in hedging and trading the positions over the distribution period.
Note – The new issue process in bonds is intended for professional investors and moves quickly. For instance, exploratory talks between the issuer, the investment bank and key investors on pricing etc. may be held on the Wednesday. By the following Monday the outline pricing and terms of the new issue will be announced on the screens. This announcement will take the form of;
Acme Corporation to issue seven-year sterling straight, guidance is 160-170bp over gilts. Co-leads Barclays Capital and RBS.
This means that Acme will be issuing a conventional fixed coupon bond with a seven year
