Those who were looking for the answer to the billion dollar question – have the declines in the stock markets reached their extreme and it is now possible to return to investing in stocks in full force – had only to look at the graph of the stock indices on Wall Street last weekend. A look at the S&P 500 reveals that it plunged, climbed, crashed again and finished Friday higher. The Nasdaq also followed a similar path, and this instability pushes the public to look for more stable and solid investment avenues.
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Along with bank deposits, which grew by NIS 50 billion in September, and financial mutual funds, which offer similar interest rates that in some cases exceed 3%, it seems that the current period is bringing back into play a tool that has been pushed to the sidelines in recent years – portfolio management specializing in corporate bonds (AG) h companies) offered by the investment houses.
The reason the product has lost its appeal in recent years is also the one that makes it attractive now – its dependence on interest rates, and the effect of the increase in central bank interest rates on the bond market.
While in recent years the stock indexes have mostly been on the rise, and presented adequate returns compared to the low interest rates that came from the bond side, the rise in interest rates creates investment opportunities in the corporate bond market that have not been seen in many years. However, it should be noted that, in general, the inherent risk in those bonds is high compared to government bonds and bank deposits.
The advantage of a corporate bond portfolio over bank deposits is first and foremost the higher yield potential, thanks to the risk premium (additional yield) that corporate bonds pay investors.
The investment houses divide the bonds in which they invest into two types. The first is shekel corporate bonds, with a current yield that they currently estimate to be about 4.5% per year at an interest rate of between two and a half to 3.5 years, and the second type is bonds linked to the index, guaranteeing 1%-1.5% in addition to the index, and the division between them is usually 50% for each type.
This is when customers can choose to increase exposure to each of the bond types, or to combine exposure to shares in the managed portfolio, for those who want a higher return at the price of increased risk.
“It is a diversified portfolio, with a holding of 2-3% in each company, and the companies are spread over several sectors,” says Eitan Rotem, CEO of Meitav Portfolio Management of the Meitav Investment House. “The diversification gives more stability and less risk, and half the tight portfolio The index creates protection against inflation, in case it surprises and continues to rise.”
He gives as an example the bonds of the Electric Company, which will mature in about two and a half years and which offer an annual return of 1.2% plus the index. The bonds of the Phoenix Insurance Company give a return of 1.6% plus the index per year, and those of the Harel Insurance Group also offer similar returns for a period of about four years.
“There are companies that even provide bonds that increase the level of security in case there is a bad business. The real estate company that yields Mega Or, for example, which worked for the benefit of the bond holders of the Big Centers in several locations, such as in Pardes Hana-Karkur, and it offers a yield to maturity of 1.7 % plus an index, and all the ratings are high investment ratings – the AA group,” explains the CEO of Meitav’s portfolio management, who manages assets of approximately 67 billion shekels out of the 300 billion shekels managed by the industry as a whole, a figure that makes Meitava the largest in the market.
Eitan Rotem, CEO of Meitav Dash Case Management / Photo: Yeh’ach
Among the shekel bonds, Rotem mentions those of Bezeq, which give a yield of 4.3% (as of Sunday at 1:00 p.m.) with a maturity of less than two years, and those of the Israel Company, with a yield of 4.3% for a period of two and a half years. He also mentions Discount Bank’s bonds, which give a yield of more than 4%, higher than the one offered by the bank as interest on deposits.
Another advantage concerns taxation. As in the financial funds, the taxation is only on the real profit, while in the deposit the tax is 15% of the entire nominal profit, which means it will be paid in any case. In linked bonds, the tax index is 25% on the real profit, so if inflation were higher than the yield on the bonds, the customer would not pay tax.
The bond can be sold every trading day
To join portfolio management at an investment house, the client will usually have to put up an amount of between NIS 250,000 and NIS 400,000. For the service, he will pay a management fee of 0.6%-0.8% for a portfolio of one million shekels, and as the portfolio grows, the management fee decreases. Currently there are more than 100 managing companies, and they can work with clients of all banks, by defining them as a proxy in an account at the bank that must be defined as a managed account.
Beyond the return it may generate for the client, portfolio management benefits from additional advantages compared to bank deposits. While the bank deposit is closed for the time period chosen by the customer in advance, the bonds are liquid, because they are traded on the stock exchange, and therefore can be sold every trading day.
“If the client needs the money tomorrow morning, he can sell the bonds,” says Gil Dotan, manager of the premium department who manages the entire array of private clients at IBI’s portfolio management company.
“Liquidity capacity is essential not only from the aspect of a customer who needs the money, but also from the aspect of fear of substantial changes in the inflation rate, or opportunities to purchase more attractive bonds or any other investment that may yield a higher return.”
Gil Dotan, manager of the premium department, IBI case management / photo: Ilan Bashor
Shai Yaron, CEO of portfolio management at Altshuler Shechem, also refers to this advantage. “Since this is a diversified portfolio, without focusing on a specific series, we have the possibility to take advantage of opportunities if the yields continue to rise, because the portfolio is liquid and generally has a relatively short maturity. Therefore, it is likely that if interest rates rise and bond spreads open, investment managers will know how to take advantage of the opportunity and even improve the internal yield.”
Rotem also notes the great advantage of liquidity for the client, but also warns that the yield to maturity refers to the entire period, and redemption before its end can have consequences, for better or for worse.
“An investment portfolio consists of bonds that are traded, and the manager can be instructed to sell every trading day. The sale, in accordance with the client’s request, may occur on days when there are price drops, and it will be carried out according to the bond price set in the stock exchange trading, so that it will be impossible to guarantee the client that the portfolio will not decrease from the value it started with. On the other hand, it can also be profitable if the bond price has increased “.
“Diplot rate and settlements among the lowest in the West”
The choice of managing portfolios specializing in bonds is intended by the investment houses for those who prefer a solid investment channel, but still want to make a slightly higher return than the deposits in banks, even if this involves a slightly greater level of risk.
Thus, in the event of a deterioration in the company’s solvency to the point of needing a debt settlement or even a haircut – when those who will bear the loss are the bond holders – “this risk is relatively small, because the portfolio managers are constantly monitoring the portfolio, which is why the portfolios are invested in bonds in the highest rating and not in companies with a low rating. The managers also do not allow holding a high rate in any of the bonds,” says Rotam.
In this context, Dotan points out that “the rate of deposit and settlement in the local capital market is among the lowest in the West, so it is a relatively safe investment.”
Another risk lies in a sharp increase in bond yields following an interest rate increase, if and when this continues beyond the rate already embodied in bond prices. “So capital losses may arise for the client if he redeems the investment before the end of the period. However, if he holds every bond until redemption, these capital losses will not materialize,” Dotan points out.
The investment house emphasizes that they avoid investing in the bonds of leveraged companies, or those that will have difficulty repaying the debt to the bond holders. An example of such bonds can be found in the bonds of companies such as Haim Katzman’s G City, whose series 13 trades at a yield of 13%, its parent company Norstar, with a junk bond yield of 27%, or Shekel bonds of Hajj Europe with a double-digit return.
How do you differentiate between a company whose bonds are worth investing in and one that is too risky?
Rotem: “This is the work of the analysis and research department. Obviously, the goal is to buy bonds where there is a high certainty that the company will service its debt, whether it is in the form of liens or cash flow that will ensure that it does not need to raise money from the market in the event of a deterioration, and see the G City value. We won’t take the risk and we won’t run for a return of 8-9%, because we don’t want to end up in a situation of default in repaying the debt.”
Yaron: “Investment houses do not rely only on the ratings of the rating companies. We have an analysis that checks every bond, meets the companies and analyzes their reports. We are looking for the repayment capacity and not just the imagination or the potential to grow, which is a parameter that is more interesting to those who own the shares.”
Which sectors do you recommend and which ones should you stay away from?
Dotan: “Preferred sectors are the more defensive ones, such as the banks, insurance companies, large communication companies and also real estate among others, but bonds of large and stable companies with a strong flow, which belong to the yielding real estate sector and not to startups. Of course we will not invest in leveraged companies.”
Rotem: “We also focus on sectors of stable companies with flows, such as the banks, insurance companies, electricity company and Bezeq, and stay away from entrepreneurial real estate, because it cannot provide security for investors, or real estate companies that are not required to access the market in the coming years.”
How do you see the bond market compared to the stock market?
Rotem: “We never recommend being outside the stock market, and it is recommended that the stock component be part of the portfolio, because of the yield potential in the stock market. If you follow the rule of the inverse multiplier in the stock market – when the multiplier after the profit in the stock market is in the 16th region, the inverse multiplier, That is, a return of 1 divided by 16, gives a little more than 6% return per year. Compared to a 4.5% return in the bond market, this is no longer a sufficient risk premium at a time like this.”