Date: 2/9/2010
Author: John Radtke

New Issue Bonds: Features and Risk Considerations

Bond ETFs are gaining a substantial following among portfolio managers and investors. ETFs based on fixed income instruments are now about 20% of the total ETF market and bond ETF issuance has increased significantly in the last year.

Bonds ETFs offer instant diversification and tradability. But for many long term investors, Bond ETFs are still an unproven newcomer on the bond block. Bond mutual funds and individual bonds continue to make up by far the greatest percentage of current fixed income allocations.

Owning individual bonds in a portfolio may seem like ‘old news' for some persuaded by the appeal of ETFs. However, many financial professionals do not consider bond ETFs or bond funds to be true fixed income instruments.

  • Individual bonds are designed to return principal at maturity or call date. This is not the case with bond funds or ETFs, which have no stated maturity. Bond funds and bond ETFs typically have a ‘rolling' average maturity date or duration, with no certain maturity value. In practice, they are not by definition fixed-income securities.
  • Unlike bond ETFs or bond funds, individual bonds are typically purchased for a stated stream of cash flows. With individual bonds, the adviser and investor control which bonds are held in a portfolio.
  • With bond funds and ETFs, an ever-changing assortment of securities is under the control of the fund or index manager.
  • Additionally, interest rate risk tends to decline as a bond nears maturity. This may make individual bonds less vulnerable to changes in interest rates than bond funds and ETFs. John Radtke, President of Incapital LLC

When considering individual bonds for fixed income allocations, new issues are often recommended. What are the potential advantages of new issue vs. secondary market bonds?

In many bond sectors, the new issue market offers investors an entry point which can simplify portfolio decisions with tax efficiency and clarity. While municipal bonds may be more difficult to purchase as new issues, several corporate and US Agency issuers offer bonds consistently in the new issue market.

Pricing Clarity

New issue corporate bonds are typically offered at a par amount of $1,000 per bond. Secondary market bonds normally trade at discounts or premiums to par, with accrued interest. With no discount or premium pricing on new issue bonds, the coupon on the bond will equal the yield to maturity.

Tax Considerations

At maturity a new issue bond will not incur capital gains or losses. Secondary market bonds almost always have more complicated tax consequences.

Underwriting Fees

When buying a new issue bond, all underwriting fees are disclosed in the offering documents. Issuance fees typically range from 50-150 basis points on non-callable bonds, depending on the maturity and structure.

Consistency

For issuers offering a regular program, new postings are set each Monday. In most cases these offerings are available until the following Monday. This allows advisers and investors time to make an informed decision. The price (par) and coupon remain constant throughout the week, with all investors receiving the same yield to maturity when the issue closes.

Liquidity

While designed for buy-and-hold investors, liquidity is provided by numerous market markers. In the event of a market dislocation or credit concerns with respect to a specific issuer, bid-ask spreads can be wide. However, secondary issues normally trade in an orderly market and are reported on TRACE (see SIFMA's site investinginbonds.com).

New issue bonds can offer real advantages for the ‘slow and steady' portion of a portfolio. All major custodians and broker-dealers offer new issue bond platforms in the corporate and US Agency sectors.



The investment products discussed herein contain unique risks, terms, conditions and fees specific to each offering. Depending upon the particular investment product, risks may include, but are not limited to, issuer credit risk, market risk, the performance of an underlying derivative financial instrument, formula or strategy, and foreign currency risks. Return of principal may not be guaranteed and may be subject to credit risk of the issuer or the performance of a derivative instrument, formula or strategy. Additionally, unless otherwise specified in the particular offering documentation, the products discussed herein are not FDIC insured, may lose value, and are not bank guaranteed. You should not purchase an investment product or make an investment recommendation to a customer until you have read the specific offering documentation and understand the specific investment terms, conditions and risks of such investment. A copy of the official statement and other offering information may be found at the SEC’s EDGAR as related to securities offerings. Incapital will also provide copies of the relevant offering statements upon request. Incapital does not offer or sell investment products to individual investors. Investors should consult with their financial professional prior to investing any money in these or other products and carefully review the disclosure statement or other offering documents.

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