One of the most effective tools available to a fixed income investor with the cloud of rising interest rates hanging of over the market are kicker bonds. Forbes has even been touting the strategy as far back as 2010. The MSRB defines a kicker bond as:
“A callable high coupon bond sold at a premium and priced to a specific call date. The actual yield realized by the investor increases or “kicks up” if that call is not exercised”.
The general strategy is simple; invest your funds in high quality bonds, which are callable in the short term, and have a relatively short final maturity (approx. fifteen years or less). These bonds are purchased with a yield to the first call, typically better than prevailing money market rates. Ultimately the objective is to hold on to the bonds past the first call and have the yield kick-up to a larger yield after each successive call date and finally to maturity. That is where the name, Kicker Bonds, is derived from.
If one was to purchase the following bonds:
NY Metropolitan Transportation Authority (MTA)
Revenue Bonds CUSIP: 59259YRF8
Rates A1/AA- (Moody’s/S&P)
5.00% Coupon Maturing 11/15/2023
Ideally, these bonds would be purchased around a 1.00% yield to the first call on 11/15/2017. If the bonds remain outstanding this would allow the yield to kick up to through a 4.50% to maturity. Even more impressive than the yield to maturity is the yield schedule. As the bonds remain outstanding, the yield quickly kicks up dramatically compared to market rate bullet notes of the same duration.
While there is a higher probability that most of the bonds will not remain outstanding to maturity, the higher than market return awarded by the ones that do remain, far outweighs the slight call risk assumed.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.
All bonds and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.
Municipals and tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-parties and Las Olas Wealth Management of Nat Alliance Securities LLC does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.
Dean Myerow is a municipal bond market asset manager and along with partner, Sean Vesey the team structures institutional and high net worth investor portfolios at Las Olas Wealth Management of NatAlliance Securities LLC.