Bonds aren’t meant to be risky investments, especially not those issued by blue-chip companies. So when GM and Ford, two industrial stalwarts, had their bonds downgraded to junk last week, people took notice.
“For bond investors, a 20 percent to 30 percent loss like this on a bond is far from expectation—you’re just hoping to clip your coupon,” says Jeff Hussey, head of fixed income at Russell Investments. “The talk is about oil prices and struggling SUVs, but the cost structure of these firms is a bigger worry—the pension obligations and, particularly, the health care obligations.” He adds, “This certainly calls in to question the assumption that these guys will never fail.”
Indeed, last month was the first sign of frailty at the industrial giants for quite some time. General Motors revealed a $1.1 billion quarterly loss, its biggest since 1992 when the carmaker was on the verge of bankruptcy. For a lot of portfolios seemingly protected by value and conservative investments, that was sobering news. Fortunately, the downgrade did minimal damage to the stock prices of the firms (Ford closed today at $9.64, down 21 cents from the day before the bond downgrade. GM $31, up 50 cents.)
Hussey says GM and Ford make up about 1 percent of the Lehman US Aggregate Index, which is market cap weighted, and he guesses most retail portfolios are similarly exposed, though “for investors with ladders of individual bonds, it could be as high as 5 percent.”
Or more. Greg Ghodsi, a broker at Robert W. Baird, says he oversaw a portfolio restructuring for a younger broker’s new client four months ago that was substantially overweighted in GM bonds.
“Had it not been redone, it would be a real mess right now,” says Ghodsi. He says this event will be another lesson in asset allocation for investors and brokers chasing performance: “For a while now, before this started to appear, I was getting calls from clients to buy more GM bonds, and I just had to tell them no because the position was solid,” he says.
Ghodsi says he has about 60 clients with GM and Ford bonds in their portfolios, but that they only make up 1 percent to 2 percent of holdings. For now he says he’s just tracking the status of the two firms very carefully.
“It doesn’t look like bankruptcy is imminent, so they must continue to pay the bonds,” he says. One of the attractions of many of the bonds, especially if they’re GMAC bonds, says Ghodsi, is that if the owner dies, the surviving spouse has the option to sell them at what they were bought at. (General Motors Acceptance Corp. is a wholly owned subsidiary of General Motors Corp. and operates under the brand name GMAC Financial Services.)
“Unfortunately, it doesn’t help you until you die,” he says. These so-called “smart-notes” might not be honored if the company files for bankruptcy.
Hussey says if the bonds become more distressed—which he says is a good possibility—it will present a good buying opportunity. As of yesterday, Ford and GM were rated as if they were double “B” bonds, but trading levels were characteristic of single “B” levels, he says, meaning investors are waiting for lower prices before they consider the bonds worthy of purchase again.
