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What's In a Name?
Sunday 12, February 2017

What’s In a Name?

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What’s in a name? that which we call a rose

By any other name would smell as sweet;

 
 

                                                Shakespeare’s Romeo and Juliet

This week, we are highlighting the significance of names when selecting investments.  The typical conversation with a client starts with the investment advisor giving the client a list of bonds or stocks that they are to consider.  The average client will say:  “Oh I know that company, I do business with them.  I will buy that one!”  However, going off of name alone is not sufficient for an investment strategy.  I will highlight the pitfalls of using  name recognition to the exclusion of other more sound practices.

Firstly, you are not alone, we all base decisions on name recognition.  This is a shortcut to bypass excessive work and to make quicker decisions, it is the root on which prejudice is based, i.e. making pre-judgements on a large scale without analysing each specific case.  Of course, if you are buying a pair of jeans, it makes sense to stick to your favourite brand where you know the fit and the quality.  However, the equivalent in investing would be ratings, as it is the most objective, though not perfect, method of assessing different investment options.  Ratings are a tool that you can employ to assist you, especially when comparing different options.  Even across regions, an investment grade rating (BBB- and above) means that the bonds would have met similar criteria.  We have to remember though that the higher the credit quality the less the company has to pay to investors.  So there is a constant need to balance risk and return.

Secondly, what you don’t check can hurt you.  Did you know that a company can default on their bonds and still continue in business?  That means that you can continue to patronize their services but forfeit your investments on your bonds in the company.  That is why it is essential for you to check out the financial performance of the company before you make the decision to invest.  Check out how much capital they have (the equivalent of an individual’s savings).  How is their cash flow?  Are they making enough to pay their bills and their debts?  How is business?  Does it appear to be viable? Are the prospects good? Are they expanding?  You have to ensure that you are not investing in a typewriter business when everyone is using computers!

Thirdly, consider the nature of the investment.  Different structures have different liquidity risks.  Certain types of investments are far more difficult to sell than others.  Let’s look at bonds.  Some bonds are traded internationally and this adds to the liquidity, that is the ability to sell it readily.  Other bonds may be traded only locally, this will reduce the market and tradability of the bond.  You may be invested in a preference share structure.  In any case, the structure makes a huge difference in your ability and speed to sell the bond.  

 Ask your investment advisor how quickly you can redeem the investment if you need funds.  Will the company buy back the bonds from you or will they wait to find a buyer?  Are they going to buy back the bond at a very discounted price?  This is especially typical when the true minimum investment amount of a bond may be US$100,000 for example and the financial institution purchases a block and then resells it in small pieces.  This is very helpful for the client.  However, if the client needs to sell the piece back to the institution it is likely to be at a steep discount.  Clients may not be aware of this.

Finally, there is nothing wrong with investing in a name that you recognize, but you still have to do your due diligence, a company can look good on the outside, but may not stand up to closer scrutiny.   Pretend you have never heard of the company and analyse it as if it totally unknown.

Yanique Leiba-Ebanks, CFA, FRM is the AVP, Trading &  Business Development at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

  

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