Bond Investing

This Bond Is a Trap – and the Pros Should Know Better

Everyone by now is well aware of the fact that interest rates have been – and by recent measures, will continue to be – at near-record lows for some time.

The Fed’s efforts to increase the rate of inflation have been, for the most part, ineffective. And the interest paid to bondholders has remained very low by historical standards.

Most of us have adapted to the shift to the new normal, as it’s being called, by adjusting our expectations. But there are still those who think you can get blood out of stone… or in this case, double-digit yields in a low single-digit market.

Take the case of the Chinese property developer Kaisa. It recently issued new bonds at 12.25%, and the offering was met with strong demand.

Here’s the problem: If you can get 6% from a similarly rated bond, it’s a great deal. A rate of 12.25% is insane.

Almost one-fifth of the bonds issued were purchased by U.S. investors – but it wasn’t Joe Mainstreet jumping in with both feet with big numbers in his eyes. This was a sale for institutional investors only.

The big guys – the ones who are supposed to know what they’re doing!

To be honest, I am beginning to wonder if they do know…

Consider the fact that Kaisa defaulted on its debt as recently as 2015 – $2.5 billion in overseas debt. The issue stemmed from new restrictions put in place by the Chinese government on Kaisa’s properties with no explanation.

And when you consider that this most recent debt offering was Kaisa’s fifth this year for a total of another $2.35 billion, you have to wonder: What the heck?

The housing market is slowing in China as the government toughens up on banks and lending practices.

China’s growth hit a multidecade low recently.

The manufacturing sector has seen significant slowing.

And price growth in housing is expected to fall to 3% from 6% in 2020.

This is where the pros put billions into the housing market?

I’m sorry, but 12.25% and other pie-in-the-sky bonds look great only until the ax falls. And based on this company’s history, I wouldn’t be surprised to see it happen again.

I know it’s an old, overused saying, but it is so true: If it looks too good to be true, it is.

If a borrower, Kaisa in this case, has to give away money – and 12.25% is giving it away – there’s a reason. And the argument that China has great growth prospects doesn’t fly here.

I have ranted in many pieces about the dangers of bond mutual funds that manipulate their yields by using leverage to lure investors. That’s a big enough problem that will eventually cost their investors billions.

But this is so blatant, I have to wonder why any thinking person would get involved. And in this case, get involved again.

Be careful out there. It isn’t just Chinese property developers who are playing small investors like a flute. The pros know the current rate environment is slowly starving the little guy, and it’s a perfect opportunity for the less scrupulous to skin him.

There is an endless line of people just waiting to make your money theirs. Don’t give them the chance.

Remember: If a rate is above the market average, there has to be a reason.

Good investing,

Steve


About

Somewhat of a renaissance man, Steve worked as a professional broker and has been an active trader of bonds for more than two decades, specializing in ultra-short-maturity corporate bonds. But before entering the investment industry, Steve was a naval aviator, flying fixed-and rotary-winged aircrafts, and also served as a surface warfare officer. Steve’s regular video series featured on Wealthy Retirement called “Slap in the Face” Award is some the most amusing investment content we republish.

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