Ian Robinson, Head of Credit Strategy at F&C, says the latest craze in bond issuance is ‘step-up perpetual subordinated corporate debt.
These are bonds with no redemption date but where the issuer has a call option to buy the debt back after a pre-determined number of years. As a hybrid form of capital they sit ahead of the share holders in claims on the issuer’s assets but behind the conventional bondholders in the event of a wind-up. Investors in subordinated debt are rewarded for the extra risk with a higher level of yield.
“These types of instruments are a new development for non-financial companies but hybrid capital has long been used by banks as the regulators regard it as closer to equity than debt so it keeps the cost of capital down,” explains Robinson. “In the quest for yield the added spreads available on these instruments can be attractive provided the underlying company is of a high quality. The step-up is an incentive for the company to call the bonds but the possibility that the security becomes perpetual in nature is a risk the bond investor must bear.”
Although there have been one-offs in the past, this month there have been several new Euro denominated issues including Suedzucker and the Danish National Oil & Gas Corporation. The F&C credit team have recently made their first investment in this hybrid debt, participating in a 1 billion Euros step-up perpetual issue by Swedish energy company Vattenfall which has a coupon of 5.25%. The stock is being held in a number of the F&C retail bond funds including the F&C Fixed Interest Fund, managed by Citywire A-rated Robinson.
“If this relatively new form of capital takes off,” concludes Robinson, “it will improve the opportunities for investment grade funds to increase returns at a time when bond yields remain historically low.”