Why do punters invest in Capital Notes?
I put this on Sharechat in May 2003 when people were asking why Capital Notes were so popular ... still pertinent
One good example is Fletcher Building. You get now get FBU March 2006 notes for a yield of 8% - but the dividend yield on FBU shares at todays price is 7.9%.
With the FBU note rate being 3% above what you can get for March 2006 Govt stock the 'company risk' is 3% and built into the notes price. Seems a fair enough risk premium.
But if you define the 'equity risk' as the difference between the bond rate and dividend yield (in this case being 0.1%) you would have to say there is essentially little risk in buying the FBU share.
Even if the FBU shareprice doesn't move over the next three years
shareholders are no better or worse off than notes holders - but the notes holders have denied themselves of the benefits of increasing dividends and capital gains from an appreciating share price,
Buying a FBU note presumes (?) that the investor has confidence in the future of FBU - then why not partake in the future gains that the company makes.
The FBU shareprice back then was $3.26 - so 18 months on the Capital Notes holders are still collecting their 8% interest and have forgone increased dividends and a 120% capital gain.
Even with a FBU shareprice at 718 the expected gross dividend is 7.3%. You can get FBL 09 Notes today for a yield of 7.45% so the perceived 'equity risk premium' in respect of FBU is still essentially zero - the market is saying there is no added 'risk' in buying FBU shares (instead of buying the Notes). The market is also saying that the FBU 'company risk' has also reduced over the last year or so - there is now only 1.5% points betweeen FBL Notes and equivalent Govt Stock.
So why does the NZ investors love affair with Capital Notes continue?
There is no risk premium built in and they are doing themselves out of millions in not partaking in the growth of the company they are generously funding.
Goodness only knows why