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Today's Commentary: 06.28.04
Initially Inticing
As the F.O.M.C. prepares to meet; as the S.E.C continues to deliberate; as the access to the IPO markets remains elusive; as the run to TIPS is no longer making that investment attractive; as JOBs continue to fall behind the curve, a new investment is making its debut, if the fixed income sales folks have their way and they call this little adventure into high risk, IDS.
On the surface, these actually seem like a worthy bet to play. Michael Santoli of Barron's said it best when he called investing a "probabilistic pursuit requiring imperfect analyses of many possible outcomes". He continued on to say that the most successful gamblers understand that the majority of their bets will not pay off but chasing that slim chance of winning is worth continued play.
In the case of IDS investments or Income Deposit Securities, the risk is not always as clear as the probabilities seem. These quaint inventions are not new at all for the large institutional investor but offering these - and there is really no other good word for it - junk to the average investor is why the S.E.C. is hesitating.
The underlying risk in these fixed income securities is plain to see but the offer of higher than high yields may be too much to ignore. Currently the Ten-year Treasury is yielding 4.6% while the average high yield index is 8.5%. When these offerings dangle 10%, heads will surely turn.
The companies looking to borrow money in this way realize two significant things that investor should take into consideration as well. These entities were unable to garner any financial support from the equities markets. Even with the current string of successful IPOs, none of the companies resorting to IDSs would even catch a second glance.
That leaves the fixed income market, a worrisome bunch of investors who seem hesitatant to chance problematic companies who are paying almost all of their cash flow to satisfy the financing. Adding the underlying offer of equity in return for their risk, investors in this kind of junk offering will either make more than the average investor through the probabilistic time ahead.
Understanding that this is an extreme case of borrowing from Peter to pay Paul is only half the battle facing these companies. The S.E.C. hurdle has backlogged these applications for almost a year. That has allowed the Federal Reserve to catch up to these offerings, even if it was unintentional not to mention unavoidable, as they begin the long overdue raising of short-term rates.
The effect it will have on 10-year Treasuries, slightly off their recent highs of 4.85% will remove much of the advantage offered in IDSs. Even with the limited analysis and prospective forecasting, there is little chance that the IRS will be smitten with this idea. Underlying the debt is the presence of equities making the gain from the loan more difficult to gauge.
And taxes play a bigger part because of the murkiness of the investment. Companies may be left footing the bill as investor decide not to push the issue believing that the cost of complaining may actually shift the focus to them.
Investors are likely to ignore the warning signs admitting to themselves that there is now where lese to go to capture significant gains. With TIPS having inflation protection but little in the way of return, their excuses will sound more rational, at least to that little voice in their heads, forcing them to increase the bet.
The Blue Money Report
Financial Commentary covering a wide range of topics concerning money, investing, and how it effects the average investor and their financial health.
It is the World of Money and Investing Explained.
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