Peter Demirali
Managing Director and Portfolio Manager
BAB vs. JNJ
August 14, 2010
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The Build America Bond (BABs) program continues to garner increased interest on the part of institutional and international investors. Foreign investors are playing a larger role as buyers of this asset class. Some have estimated their participation at anywhere from 25-40% of an issue, especially for large, index-qualified debt. Given the problems and concerns of sovereign debt in places like Greece, Spain, and Portugal, it is not surprising to see international investors hedge their bets and diversify more than they might have previously. Additionally, spreads on similarly rated corporate debt are extremely narrow to Treasuries. In most instances, corporate bonds offer lower yields than Build America Bonds with the same or similar ratings.
Johnson & Johnson (J&J) came to market yesterday, issuing $1.1 billion of securities in ten and thirty years. The two tranches were equal in size and were priced at the tightest spreads relative to Treasuries witnessed in decades if not generations. J&J is one of the few remaining AAA-rated corporations and is considered one of the best-run and most profitable enterprises in the world. The ten-year bond was priced at a spread of 43 basis points over Treasuries and has a coupon of 2.95%. This company was able to borrow $550 million for thirty years at a spread of 68 basis points and pay interest of 4.50%.
The company clearly believes it can generate earnings that are higher than what it will cost them to borrow these funds.
Over the course of the last month or so, we have seen a number of AAA-rated municipal issuers come to market in the Build America Bond program. The University of Virginia (UVA) issued thirty-year bonds roughly three weeks ago at a spread of 95 basis points. Currently these bonds are trading five to ten basis points narrower in spread. Investors can sell their JNJ bonds and pick up over 20 basis points in yield by purchasing UVA bonds. As an aside, UVA was one of the first to issue Build America Bonds in early 2009. The spread at issuance was approximately 250 basis points over Treasuries, and approximately 150 basis points over JNJ thirty-year debt. Clearly, these bonds were a great buy at those spreads and still offer value today.
Other issuers with AAA ratings in the municipal area that have sold bonds recently are Texas Transportation Commission, Ohio Water Development Authority, Arlington (VA), and Columbus (OH). There has been no shortage of high-quality issuers coming to market and each deal was several times oversubscribed. To illustrate how attractive these bonds are when compared to JNJ debt, Texas Transportation bonds were issued at +115 to Treasuries, Ohio Water came +95, Arlington VA came at +120, and Columbus OH came at +150 over Treasuries.
Cumberland Advisors continues to favor this asset class over corporate bonds and mortgage backed securities. Build America Bonds comprise the majority of holdings in our total return taxable bond portfolios. It has provided our clients with significant outperformance relative to our benchmarks and greater diversification. The high relative yields also helped generate compelling returns in our Build America Bond Spread (duration-neutral) strategy. This strategy is an alternative to money market mutual funds and bank deposits that yield close to zero.
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Peter Demirali is a portfolio manager and heads Cumberland’s taxable fixed income area and is a long time veteran of taxable fixed income markets. He is a member of Cumberland Advisor’s Management Committee. His bio may be found at www.cumber.com.
Comments on this article may be directed to peter.demirali -at- cumber -dot- com
