Dan Atkinson
It’s that point in the economic cycle once again. It comes around like New Year’s Eve and usually leaves behind the same trail of wreckage, destruction and blinding hangovers. Yes, it’s junk time.
Some of us can remember this X-rated film the last time it was showing. How we thrilled to the transatlantic antics of Michael Milken, the king of junk. How we sobbed during the tragic final scene in February 1990, when 2 000 employees of Drexel Burnham Lambert – the investment bank that was Milken’s former base – staggered up Broad Street, Manhattan, for the last time carrying their belongings in cardboard boxes.
Now junk, as in junk bonds, is back. Of course, no one selling them ever called these bonds – which yield a good few percentage points above top- grade bonds such as gilts – junk. “Below investment grade” or “higher yield” sounds more reassuring.
They have a long history, if not a fine pedigree. In the Eighties, Sir James Goldsmith famously described his own junk – with which he tried to take over British American Tobacco (BAT) – as practically gilt-edged. No one is being quite that cheeky this time. Not yet, anyway.
But junk bond is a term used to describe two quite different things.
The first, as in the Goldsmith/ BAT case, is a piece of paper with no intrinsic value issued to shareholders of a target company. They accept in the hope it will be worth a fortune once Goldsmith’s corporate raiders loot the company and sack the staff.
Junk bonds proper, however, are issued by companies that are low-rated by the market.
Maybe the issuing company has hit one crisis after another and conventional investors are just not interested in management claims that the corner is being turned and light has appeared at the end of the tunnel. Or maybe the issuing company is low-rated because it is working on the edge of scientific advance and dividends are perhaps a decade in the future.
As a result, the “yield” on these bonds will be far higher than on conventional, and safer, corporate paper. But you can’t, of course, have higher yields without higher risks.
Junk sellers always find a case for junk. Firstly, they say, “investment- grade securities” are a myth. There are blue-chip investments you could have bought at certain previous peaks in the stock market that would still owe you money. Think of the great names of commerce and industry that have gone to the wall.
Secondly, someone is taking those higher yields on junk, just as someone is betting at 100 to one on three-legged Danny Boy at Turffontein against three to one favourite Feather Duster. The risks are enormous, but so are the potential rewards. Yields on investment-grade securities are maybe half those available on junk.
Thirdly, and finally, markets are notoriously slow to forgive past failings and upgrade a recovering company. Why shouldn’t you nip in ahead at a bargain price?
Browse in the junk shop by all means. But don’t become a junk junkie.