This month, we look at bond proxies. While they are actually shares in a company, rather than a bond, they are so named because investors perceive them to have almost bond-like qualities. Specifically, they offer steady returns and sustainable dividends.
What exactly are bond proxies?
Bond proxies are companies that generate strong cash-flows and high returns on their invested capital. This gives them options to reinvest in the business, enhance shareholder growth or increase dividends – all undoubtedly positive things for investors.
Historically regulated companies, such as utilities, have been considered bond proxies by virtue of a regulatory environment underpinning returns. Here, the regulator sets both the pricing and the returns that companies can generate over multi-year periods, resulting in steady cash flows and earnings – hence bond-like properties.
More recently, investors have also looked to companies enjoying higher barriers to entry as bond proxies. Barriers to entry, such as intellectual property or patents, allow these companies to earn higher margins sustainably, and for longer.
Another trait shared by many of these companies is relatively low borrowings. This can put them in a strong position during times of market stress, and allows them to make value-creating acquisitions at opportune moments.
Is it all positive for bond proxies?
During the last quarter of 2016, some pundits started to talk about ‘the bonfire of the bond proxies’. This was because bond yields were rising, which also put pressure on bond proxies.
However, with the solidity, potential high returns and strong cash flows of these companies, we still believe that there are compelling reasons to own them as part of a diversified portfolio over the longer term.
We would always suggest that you speak to a professional adviser should you like to explore the world of investing more. However, it is pleasing to know that there are options out there that could provide higher returns than cash savings. Speak to us and find out more on 708090.
