Clipping Coupons

By: Ed Ingalls
December 16, 2020

One of the most important parts of my first job as an assistant equity analyst was to grab the Wall Street Journal the day they had the ¼ page coupon to cut out, check off the companies that we were interested in getting financials from, and getting it off to the mailbox asap.  Typically, a week or two later, an annual report or 8K would arrive in the mail.  My boss would read them immediately, and I would take them home to read at night after MBA class.  Value added from security selection was often an exercise in who could get and process information first.  It wasn’t the era of actually clipping coupons, though we did from time to time get physical certificates delivered as a gift to the endowment which had coupons still attached.  As an aside, Ace Greenberg (of Bear Stearns fame) made a fortune knocking on doors and buying up old bonds with coupons attached for pennies on the dollar.

Many of you who grew up in the bond business when Treasuries had two-digit yields will remember hovering over the Telerate for the jobs numbers on the first Friday of the month, and perhaps buying or selling Treasuries based on your rate positioning.  Trades would be done over the phone, and you’d calculate the yield and accrued interest on a Monroe Bond Trader, write the result on a physical ticket, and hand it over to the “back office.”   It was a revelation when I learned how to calculate convexity using a back of the envelope method on the Monroe!

Bid – offer spreads were often 1-2 points, as investors had few sources for pricing information.  Liquidity was sociable for the day – at least in trying to buy or sell at a price – before regulation cut balance sheet capacity.  Now, the ETF ecosystem is slowly becoming the source of liquidity, along with derivatives.  Sales was all about relationship management, along with some innate knowledge of which customer might care about which bonds.

My, how times have changed!  Electronic trading represents nearly 100% of our Treasury business, and about 75% of corporate trading.  Alas, except for MBS pools, much of our securitized trading is still often done over the phone.  $100 million corporate “portfolio trades” with 100-line items can be done and processed within an hour.  Bloomberg has most of the financials you might need with just a couple of keystrokes.

If anything, investors today have information overload.  Between the news, Bloomberg, IM/IB chats, dealer and third-party research, and all the CNBC talking heads, how do you parse through the noise to develop an opinion?  It is important today to employ subject matter experts who can roll up relevant data and thoughts to help steer portfolio strategy decisions.  Most data has already been analyzed by someone, although there’s always more behind that, along with an associated correlation or factor model.

Investors can get a decent handle on corporate fundamentals, and to some extent, the technicals (supply, fund flows), but making a call at the macro level still involves a fair amount of risk.  It seems more prudent to focus on security selection.  Compared with equities, there are many more ways to get invested in an issuer on the fixed income side.  For example, Citigroup has several hundred different USD issues outstanding.  There may be forced sellers of one issue versus buyers of another, creating buy/sell/swap opportunities.

How much yield differential should there be between these two bonds with similar maturities and structure: Citigroup 4.412% due 2031 versus the Citigroup 2.572% due 2031?   In general, it depends on liquidity and market tone, but call it 1bp per point of premium on average to compensate investors for liquidity and jump-to-default risk (the latter being limited in this instance).  Since these two bonds trade about 15 points apart, you should get about 15bp more yield for the higher coupon in “normal” markets.  When there is a grab for yield, the spread may narrow to 5bp or so, while in less liquid times, it could be 25bp or more.  So, although we’re not clipping coupons anymore, the coupon matters in selecting and pricing different issues from the same issuer with similar maturities and structure.  Technology changes, markets change, but the details always matter.

 

 

The above examples are for illustrative purposes only. The views contained in this report are those of IR+M and are based on information obtained by IR+M from sources that are believed to be reliable.  This report is for informational purposes only and is not intended to provide specific advice, recommendations for, or projected returns of any particular IR+M product.  No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Income Research & Management.