The author is a fixed income portfolio manager at Barksdale Investment Management and co-author of “Undiversified: The Big Gender Short in Investment Management.”
The collapse of some of the stock bubble flag bearers over the past few years has been painful for investors. We’ve seen ‘pandemic winner’ Netflix plunge 75% from 2021 highs, crypto exchange operator Coinbase plunge 86%, and former meme stock and movie channel AMC lose 80% .
Less noticed are the losses of their bonds. Damage there is more moderate and offset by coupon payments – a Netflix bond maturing in 2030 has yielded negative 19% from recent peaks, a Coinbase 2031 bond negative 36% and an AMC bond 2026 negative by 19%. This is partly due to the very different capital structures of individual companies and the risks of bonds versus stocks.
For hedge funds that profit from arbitrage transactions between capital structures, such differences present a playing field full of opportunities. But the spreads also highlight the differences in the ownership and return characteristics of stocks versus bonds.
First, the corporate bondholder base is largely institutional, although most investment grade rated issues are publicly registered. The publicly registered junk bond is a species doomed to extinction as onerous disclosure requirements and increased time-to-market drive companies toward private placements with institutions. While institutional investors may trade frequently, the concept of day trading and the associated increased volatility is largely a retail phenomenon in stocks.
Second, while it is quite obvious to say that the return outlook differs for non-distressed bonds and stocks, the calculations are a bit more nuanced.
Bondholders’, like shareholders’, risk of loss is unlimited if a company defaults (although in practice unsecured creditors receive an average of 35 cents for every dollar invested in a defaulting company). But our advantage is capped. Bond documents typically include a provision that a company can choose to redeem (or call) a bond before maturity and issue new debt at a lower interest rate, which means the investor does not will not necessarily benefit much from an improving balance sheet.
This means that the sky-high growth forecasts that have pushed Netflix, Coinbase and AMC stocks to their all-time highs simply cannot be factored into their obligations. Creditors still suffer from misjudgments but the tyranny of the bull cap saves us from ourselves when growth seems endless.
Finally, the performance of corporate bonds should be broken down into total return and excess return. The latter refers to the return on the bond after comparing it to what investors could earn on “risk-free” government bonds of similar terms.
So what story do Netflix, Coinbase, and AMC bonds tell? The “excess” yield on Netflix’s 2030 bond is around minus 7% from its peak in November. This means that more than half of its negative return is tied to the bear market in US Treasuries. Coinbase’s 2031 bond, on the other hand, posted a negative excess return of 28% from November, compared to a negative excess return of 5 for its benchmark. AMC’s excess return from its June 2021 peak was negative 14%.
The bond market seems relatively more comfortable with Netflix’s financial strength. Coinbase’s 2031 bond, on the other hand, reflects the skepticism that has lingered since its issuance last September. Unusually, the bond traded below par almost immediately — although the Bloomberg Bitcoin stock and index didn’t peak until November. It’s not necessarily that creditors were ahead of the game in predicting the recent crypto selloff – on the contrary, we don’t have the equity-like mindset needed for optimism. of crypto integrated into Coinbase’s peak levels.
Finally, AMC strengthened its financial position with capital increases as its shares exploded. But its bonds with a first lien, or claim on company assets, trade at a steep premium to debt versus a second lien. This suggests a constant worry about the company’s financial prospects.
Who knows where the bonds of these companies will be in a year? But the corporate stock market crash raises questions about the logic of rules that allow individuals to buy Coinbase or AMC stock but not their unregistered bonds in order to “protect” unsophisticated investors.
Barksdale Investment Management may hold shares in the companies mentioned