The argument against roll ups is that they tend to be associated with fraud, stock promotion, aggressive accounting, etc. An example of a bad roll up would be Worldcom. Some companies are a mix of a legitimate business and roll up dynamics. Large mining companies such as Goldcorp will often use their overpriced stock to buy real assets.
Roll ups often promote their stock so that they can use it as currency to buy other companies. This tends to create a pyramid scheme dynamic where the early investors will actually make money while the later investors are the suckers. The pyramid scheme dynamic can be a problem for short sellers if the short seller is too early. Reversion to the mean dubious Some short sellers like to bet on wonderful businesses turning into average businesses when all of their competitors copy what they do.
Or, the argument is that competition will enter the field and drive prices down. I think that this is mostly a bad idea. Wonderful businesses tend to stay wonderful. Some have made such arguments about Lululemon and other yoga apparel companies , Chipotle Mexican Grill, Blackberry, etc. Fads Some short sellers will bet on a fad fading away. Some people have argued that Crocs, SodaStream, Heelys, yoga apparel , etc. Macro Some short sellers will target a particular stock due to macroeconomic forces in that particular sector.
They were right. Not all macro shorts work out. If you shorted American homebuilders too early, you would have waited for several years before the bubble started collapsing in Gamestop, phone directories, etc. Cyclical industries and bubbles Short sellers may target industries that are at the peak of a cycle. Micron MU has somewhat high short interest likely because the shorts are expecting the history of the semiconductor industry to repeat itself. High profits will likely cause existing players to overinvest in new capacity, causing a huge glut of supply and massive losses for the industry.
Permabears dubious Some people are always pessimistic and want to bet on stocks going down all the time. Be careful about listening to sources that are bearish all the time e. Bad businesses and assets that are difficult to value It makes sense to short businesses that are losing a lot of money and will likely continue to lose money in the future. I like situations where promotional management is intentionally involved in a business that is almost guaranteed to lose money.
Promotional management teams will often buy advanced deposits or producing mines with some type of fatal flaw veins too narrow, mine is at the end of its life, political risk, refractory ore, underwater mining is uneconomic, etc. Many of those deposits and mines have terrible economics but are easy to promote due to high grades. In pharmaceuticals, some companies will spam a large number of drugs through phase I and phase II trials until they get lucky and have a phase III candidate.
These drugs may have little scientific basis for their efficacy but most investors are not sophisticated enough to catch on. In independent oil and gas, there are a few rare management teams that are very good at losing money e.
Miller Energy. Short sellers will target retailers where bad management teams are causing the company to lose money. These stocks also happen to be value investing favorites. I think that the value investors are wrong about these companies. Some of these shorts may have good catalysts. If a business is quickly burning through cash, running out of money will push them into bankruptcy if there is debt involved.
If an overhyped mine is about to ramp up and enter production, disappointing cash flow will reveal that the mine has bad economics and cause investors to trade the stock at lower prices. The catalyst is when investors come to that realization. Because there will be delays in the startup of a mine, the catalyst may take longer than originally anticipated. However, it is rare for them to take so much money out of a business that it is worth shorting the stock based on overpaid insiders alone.
But nothing is impossible. In other cases, insiders may be constantly using related party transactions to enrich themselves. This happens a lot in the shipping industry. Multi-level marketing tricky MLM is generally shady. MLM companies tend to be extremely profitable. Some people like to cause short squeezes in MLM companies e.
Asymmetric shorts Out of the money options and credit default swaps have much more upside than downside. These types of trades rarely pay off but make great stories when they do. Michael Burry is famous for buying credit default swaps on pools of bad mortgages, as chronicled by Michael Lewis in The Big Short. Cause the stock to go down Many hedge funds will try to cause their short positions to go down by talking to journalists, regulators, auditors, etc.
They may publish their research publicly whether it is correct or not e. Barry Minkow, who is now in jail. I think that some of these practices lead to healthier markets while other practices are abusive. The opposite can happen too. There are a lot of hedge funds that will conspire to cause short squeezes. They may transfer their shares into a cash account so that they cannot be lent out, causing buy-ins to occur for the shorts. I believe that such practices are market manipulation and are illegal if you get caught.
The popularity of these trades is a problem. Overcrowding in a short position will increase the chances of short squeezes, buy-ins, and the borrow cost going up. Bond investors care mostly about cash flow. Equity holders often get dazzled by promotional management and overvalue a stock. Sometimes the price discrepancy between the bonds and stock is so extreme that it makes sense to go long the bonds and to short the stock.
Stub trades Suppose that there are a million shares of company A. Company A owns a million shares of company B and some type of operating business that has nothing to do with company B. In rare cases, the shares of company A is so cheap that one share of company A is cheaper than one share of company B. By buying one share of company A, you get one share of company B plus the operating business thrown in for free.
These types of situations can happen when a company decides to IPO a hot subsidiary. In the tech bubble, 3com IPOed shares of its Palm subsidiary. There was a glaring market inefficiency because it was cheaper to buy Palm through buying 3com than it was to buy Palm shares directly. There are hidden fees or costs that may be extremely high. Leveraged ETFs often have excessive costs because they must trade every day. Share class arbitrage Share class arbitrage is when one class of shares should be worth more than another class of shares e.
However, it irrationally trades at a lower price than the other class usually due to lower liquidity. Arbitrageurs can take on risk and arbitrage the situation by going long one class of shares and shorting the other. They are betting on the spread going down. If the share price increases, the spread will widen and the trade will take up a lot more margin. There is a low-risk form of share class arbitrage if one class of shares can be converted into the other.
These are good trades but good luck finding them. Some short sellers will target a stock simply because the CFO resigned under mysterious circumstances and there are other red flags for fraud or improper accounting. Directors resign for various reasons e. Baratta graduated magna cum laude from Georgetown University.
He manages political and legislative risk for the firm and its portfolio companies, overseeing a global team of political risk specialists. Berman was Vice Chairman of Ogilvy and Mather. Previously, Mr. Bush and confirmed by the U. In addition, Mr. Berman has had an extensive career in the insurance brokerage business. Berman is on the board of directors of several Blackstone portfolio companies. Berman received a B. He is also involved in the Tac Opps Investment Committee.
Prior to launching Tac Opps, Mr. He joined the firm in Blackstone Real Estate is the industry leader in opportunistic, core plus and debt investing across the US, Europe and Asia. Since joining the firm in , Mr. He currently serves on the Board of Trustees of Prep for Prep. Prior to joining Blackstone in April , Mr. He previously worked at Goldman Sachs in its Reinsurance Group which became Global Atlantic upon its separation in Prior to joining Blackstone in , Mr.
Dowling also served as interim Chief Financial Officer of the University from May until January , leading all finance and treasury functions as well as cash and debt management. Before joining Brown University, he was the Founder and Chief Executive Officer of Narragansett Asset Management, where he managed funds for institutions, pension funds, and endowments.
Dowling has also worked for First Boston and Tudor Investments. Dowling has a B. Prior to joining Blackstone, Dr. Galakatos has over 30 years of industry and investment experience in the healthcare sector and has led investments in biotechnology, pharmaceutical company partnerships, and diagnostics, from startups to commercial-stage companies. Before Clarus, Dr. He earned his undergraduate degree at Reed College. Klimczak was an Associate at Madison Dearborn Partners. Prior to that, Mr.
Carey Scholar. Klimczak serves as a director of Cheniere Energy, Inc. Jon has spent extensive time in China, where he studied Mandarin Chinese at Peking University and did pro bono work for the U. Blackstone Real Estate is an industry leader in opportunistic, core plus and debt investing across the U. Since joining the firm, Ms. Morgan has expanded the caliber and breadth of capabilities it offers the portfolio. Prior to joining Blackstone, Ms. Perry chairs the Investment Committee for each of the Strategic Partners funds and is currently an advisory board member of multiple third-party funds.
Prior to joining Strategic Partners, Mr. Perry joined the board of Sponsors for Educational Opportunity SEO , which is an organization focused on narrowing the opportunity gap for minority high school and college students, as well as increasing diversity in the financial services industry.
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Learn about our editorial policies Bonds can be a great tool to generate income and are widely considered to be a safe investment, especially compared with stocks. However, investors should be aware of the potential pitfalls of holding corporate bonds and government bonds. Below, we'll discuss the risks that could impact your hard-earned returns. Key Takeaways These are the risks of holding bonds : Risk 1: When interest rates fall, bond prices rise. Risk 2: Having to reinvest proceeds at a lower rate than what the funds were previously earning.
Risk 3: When inflation increases dramatically, bonds can have a negative rate of return. Risk 4: Corporate bonds depend on the issuer's ability to repay the debt, so there is always the possibility of default of payment. Risk 5: A low corporate credit rating may cause higher interest rates on loans and therefore impact bondholders. Risk 6: Low liquidity in some bonds can cause price volatility.
Interest Rate Risk and Bond Prices The first thing a bond buyer should understand is the inverse relationship between interest rates and bond prices. As interest rates fall, bond prices rise. Conversely, when interest rates rise, bond prices tend to fall. This happens because when interest rates are on the decline, investors try to capture or lock in the highest rates they can for as long as they can. To do this, they will scoop up existing bonds that pay a higher interest rate than the prevailing market rate.
This increase in demand translates into an increase in bond prices. On the flip side, if the prevailing interest rate is on the rise, investors would naturally jettison bonds that pay lower interest rates. This would force bond prices down.
Let's look at an example. What will happen? In bond terminology, duration measures the sensitivity of the price of a bond to a change in interest rates. Reinvestment Risk and Callable Bonds Another danger bond investors face is reinvestment risk , which is the risk of having to reinvest proceeds at a lower rate than what the funds were previously earning. One of the main ways this risk presents itself is when interest rates fall over time and callable bonds are exercised by the issuers.
The callable feature allows the issuer to redeem the bond prior to maturity. As a result, the bondholder receives the principal payment, which is often at a slight premium to the par value. However, the downside to a bond call is the investor is then left with a pile of cash they might not be able to reinvest at a comparable rate. Duration is a function of maturity, so the longer the maturity of a bond is, the longer its duration will be. The price of a longer-maturity bond is therefore more sensitive to a change in rates than that of a shorter maturity bond, assuming all other things are equal.
Subscribe to the Select Newsletter! Our best selections in your inbox. Shopping recommendations that help upgrade your life, delivered weekly. Sign-up here. With that in mind, let's go back to my earlier point. If rates are going up and bond prices are going down, why would I want you to think about bonds?
Firstly, bonds as a general asset class have a lower risk measure than stocks. Secondly, bonds generally pay you a coupon — monthly or quarterly, depending on the bond — that provides you with income as part of your investment. With interest rates on the rise, bonds will pay higher coupons. That said, bonds in general can be complicated and are not without risk. You need to consider interest rates and credit risk — how worthy the borrower or issuer is — before jumping in.
If you look at shortening the duration of the bonds you own, it will help to limit the potential damage that can happen if interest rates rise. If you can attempt to remove the interest rate risk by hedging, bonds become much more interesting. There are investment strategies that concentrate on short duration, while others focus more on the products that hedge the interest rate of bonds, which essentially mitigates the risk and makes the move in rates much less impactful.
An example of an interest rate hedged bond strategy is when you invest in portfolios of investment-grade or high-yield bonds and include a built-in hedge to mitigate the impact of rising Treasury rates. In most cases, these products do their best to eliminate rate risk while short duration strategies only limit your exposure. You can also express this through asset classes such as floating rate investment grade bonds, bank loans and treasury inflation protected securities, or TIPS.
All of this can be expressed via exchange-traded funds, also called ETFs , and mutual funds. When researching which funds work best for you, consider the track record and expense ratios before making a decision. You should also consult with a financial advisor if you have one. You should also consider your equity portfolio when rates are on the rise. Just because interest rates are going up, it doesn't mean you can't still invest and make money in stocks.
That said, not all stocks react in the same way in a rising rate environment, so it's important to research this beforehand.
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Bond Investing 101--A Beginner's Guide to BondsCBB 2022 BETTING
These range from cash and cash-like assets and government bonds through to high yielding and sometimes high risk corporate and emerging market bonds. Rising yields are only one aspect of the complexity of holding fixed income investments in a portfolio. I started covering bonds just before the infamous bond market crash of Of course, it was painful while it was occurring, with the sell-off lasting around six months. But the biggest mistake investors made was getting out of bonds, given the subsequent strength of the rally.
Things are different today, but this context is important, as it is highly likely that most of the pain for bond investors has passed. When fundamentals change, alter your allocation Jerome Lander, WealthLander We believe investors need to change their asset allocation substantially in response to the changing prospects and valuations of different assets.
For example, if bond yields are expected to rise, bonds with interest rate risk longer duration may be less attractive than otherwise as bonds sell-off. Bonds can also be unattractive if the yields are too low — and artificially low — as they have been in recent years. In recent months, we have seen one of the largest ever sell-offs in long-duration bonds. Asset duration is also key Chad Padowitz, Talaria Asset Management Rising bond yields are as much of an opportunity as they are a risk.
As yields rise, they enable investors to deploy capital at higher contractual rates of return than has been possible for many years. Duration matters a lot in a time of big moves in interest rates. In short, if you expect rates to keep going up then you would want shorter duration bonds, because of this shorter time before the assets mature and the investor gets their money back.
In part one, our contributors discussed whether the model of portfolio construction remains relevant. And in part three, they each name one aspect of the market they believe all investors should consider. View Disclaimer: Livewire gives readers access to information and educational content provided by financial services professionals and companies "Livewire Contributors".
Livewire does not operate under an Australian financial services licence and relies on the exemption available under section A 2 eb of the Corporations Act Cth in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement.
Livewire has commercial relationships with some Livewire Contributors. Can you tell me more about investing in bonds so I can decide if it makes sense for me? Signed, Bondy in Baltimore Dear Bondy, This is an incredibly timely question and one that I have been answering for many clients recently. Before we get into it though, I need to provide some context about interest rates and how they correspond to bonds. Over the past 15 years, we have experienced historically low or falling interest rates.
For many investors, this is the first time they have experienced a rising rate environment, so it is important to understand how this rise in rates can impact your portfolio in the coming months and years — especially since many of the strategies we have utilized over the past few years, with varying degrees of success, may not be as effective with this recent rise in rates.
When interest rates rise , bond prices go down in value. Most bonds pay a fixed coupon i. A bond's duration is the measure of its price sensitivity in relation to a change in interest rates. Duration is a function of maturity, so the longer the maturity of a bond is, the longer its duration will be. The price of a longer-maturity bond is therefore more sensitive to a change in rates than that of a shorter maturity bond, assuming all other things are equal.
Subscribe to the Select Newsletter! Our best selections in your inbox. Shopping recommendations that help upgrade your life, delivered weekly. Sign-up here. With that in mind, let's go back to my earlier point. If rates are going up and bond prices are going down, why would I want you to think about bonds? Firstly, bonds as a general asset class have a lower risk measure than stocks.
Secondly, bonds generally pay you a coupon — monthly or quarterly, depending on the bond — that provides you with income as part of your investment. With interest rates on the rise, bonds will pay higher coupons. That said, bonds in general can be complicated and are not without risk.
You need to consider interest rates and credit risk — how worthy the borrower or issuer is — before jumping in. If you look at shortening the duration of the bonds you own, it will help to limit the potential damage that can happen if interest rates rise.
If you can attempt to remove the interest rate risk by hedging, bonds become much more interesting. There are investment strategies that concentrate on short duration, while others focus more on the products that hedge the interest rate of bonds, which essentially mitigates the risk and makes the move in rates much less impactful. An example of an interest rate hedged bond strategy is when you invest in portfolios of investment-grade or high-yield bonds and include a built-in hedge to mitigate the impact of rising Treasury rates.
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