Investing in Corporate Bonds: Spotlight on Bank of America

The Sterling Report

Pamela Davis

Sunday, February 19, 2012

AS most investors know, corporate bonds are loan instruments issued by corporate entities to raise funds for varied reasons, including: expansion, working capital requirements and to refinance high cost debt.

Corporate bonds appeal to investors who wish to enjoy higher interest income (when compared with sovereign bonds) coupled with the potential of capital appreciation on their investments. The interest, when combined with the capital appreciation, represents the total return on the investment, and can be very attractive. We urge investors to consider the concept of total return (ie interest income plus capital appreciation) when purchasing bonds. These returns are much higher than those achieved on repurchase agreements or simply holding to maturity.

In assessing the prospect of price appreciation on the bonds, investors need to take into consideration a number of factors, including: the corporate entity's financial statements, the prospects for growth, the timing of the purchase, the instrument's price history and the price of comparable instruments issued by comparable companies.

Of course, bonds can also experience a fall in price. However, at the maturity date, the investor is promised 100 cents on the dollar for his investment.

We will now look at the Bank of America bond with the above in mind.

The Bank of America is a private bank in the USA, with a total capital base of US$218 billion as at June 30, 2011. It has a capital ratio of 15.65 per cent and approximately US$2,261 billion in assets. As such, the bank is one of the world's largest banks and plays a critical role in the stability of the country's financial system.

In the recent global economic crisis, these bonds fell significantly in price, pushing yields upwards of 10 per cent per annum. Investors who bought these bonds at these levels are now looking at above average total returns as the appreciation in the bond price in combination with the interest rate on these bonds, has produced a very attractive total return. An example may highlight this point. Consider an investor who purchased US$1,000 of a Bank of America bond that had an interest rate of 6.25 per cent at a price of 93. In other words, he paid U$930 for a face value of US$1,000. One year later, assume the bond is trading at 101. If he sells the bond at this price, he will receive US$1,010 (he would also have received an interest payment of US$62.5 during the year). The investor has now earned a total return of 15 per cent; representing the sum of the 6.25 per cent coupon payment and the 8.6 per cent rise in price. As you can see, the rise in price of the bond has enhanced the return to the investor.

Bond Prices continue to trade up even further as a result of the improved market sentiment at the start of 2012.

The above example demonstrates how investors can significantly boost their portfolio returns by actively managing their investments and taking advantage of capital gains. The experts in the financial sector, specifically those dealing in asset management, know the market and can assist investors to make these choices. Consult a securities dealer who will actively and prudently manage your portfolio to ensure the delivery of the highest risk adjusted returns, and ensure that the investment strategy is within your risk appetite.

Investors, too, need to educate themselves on these types of investments and the attendant risks. In all of this we should remember, though, not to take uncalculated risks. Look for companies/securities which will nourish your portfolio, so that even when prices fall, the coupon payments are sufficient to meet your income needs and that the company is sound enough to repay you at maturity. Capital gains are not meant to be taken at the expense of high credit quality and attractive interest income.

Pamela Lewis is Manager, Investments and Client Services at Sterling Asset Management Ltd. Sterling provides financial and advisory services to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm or visit our website at www.sterling.com.jm

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Investing in Corporate Bonds: Spotlight on Bank of America