How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s

How the Wall street created the junk bond market investment fads?

In the early to mid-1980's, Wall Street firms pushed junk bonds on investors.

They touted the positive historical results of high-yield debt. 

There were major differences between the debts of fallen angels versus newly issued bonds from fragile companies.

Debt from fallen angels:

•  trades at a discount to par, 
• downside risk is reduced. 
• at the same time, the potential for capital appreciation is large. 

Newly issued debt from marginal companies 

• does not share in these above characteristics.

How Wall Street can create investment fads, only to leave investors much poorer when the tide goes out.

That didn't stop Wall Street from pushing this form of debt (newly issued debt from marginal companies), nor did it stop investors from ponying up and falling victim to these issues.

The number and size of junk bond issues grew, despite the fact that this asset class was untested by an economic downturn, which should have made investors cautious. 

Investors were happy to gobble up zero coupon bonds (where the interest accrues to the issuer but is not paid out until the bond comes due) despite the clear risks! 

It took the downturn of the early nineties to wipe out those who were too eager to pay for assets that were risky.



Faulty Logic using EBITDA propelled the Speculation

One way investors were prodded into purchasing such securities were valuation measures based on EBITDA. 

Rather than considering cash flow or earnings, companies were valued using this accounting measure which doesn't include depreciation expenses. 

A company paying its debts from EBITDA is slowly liquidating itself (as it can't make capital expenditures) and leaving itself susceptible to a credit crunch.

Such fads will undoubtedly occur in the future, and those who are able to avoid them will do well.

Read also:

• 
  
• Your investments using Mutual Funds or Money Managers
• Trading and portfolio management from a value investing point of view
• Value Investor's Opportunities in Distressed Securities
• Value Investing Opportunities in the Banking Sector
• Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions
• Where to look for Investment Opportunities
• Business value cannot be precisely determined. Make use of ranges of values
• Central elements to a Value Investing Philosophy
• The Philosophy of Value Investing and Why It Works
• Philosophy of value investing. Need to have clear strategies too
• How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s
• Understanding these changes in the investment world allows investors to earn superior returns
• What's good for Wall Street is not necessarily good for investors
• Speculators, Investors and Market Fluctuations

Shortcomings of Bonds

A bond is a contractual agreement that means you have loaned money to some entity, and that entity has agreed to pay you a certain sum of money (interest) every six months until that bond matures. At that time, you will also get back the money you originally invested - no more, no less.

The two advantages of bonds are safety and income.

If you wait until the maturity date, you will be assured of getting the face value of the bond.

In the meantime, however, the bond will fluctuate, because of

• changes in interest rates, or
• the creditworthiness of the corporation.

Long-term bonds, moreover, fluctuate far more than short-term bonds.



Bonds don't have a particularly impressive record.

• Except for a year here or there, common stocks have always been a better place to be.
• Furthermore, the return on bonds today is not much better than the rate you can get on a money-market fund.

Also, bonds, even U.S. Treasuries, have an element of risk.

• They decline in value when interest rates go up.
• Long-term bonds, moreover, slide precipitously when rates shoot up.