BCE Lessons on Fixed Income Investing

Canada’s Supreme Court has decided that the planned BCE takeover does not violate any agreement with bondholders, and that the bondholders are not due any consideration beyond the contents of their contract. Like the Asset-Backed Commercial Paper fiasco, the BCE battle illustrates the risks of fixed-income investing.

The safest bonds are offered by the government. If the government doesn’t pay on its bond obligations, then money probably isn’t worth much either. On the down side, government bonds pay the lowest interest rate among available bonds.

Corporate bonds pay higher interest rates to compensate the bondholder for the risk that the corporation won’t be able to meet its obligations. It can be tempting to buy corporate bonds to get the higher interest, but there is always a slim chance that something will go wrong.

In the case of the Bell Canada bonds, the promise to pay the bond principal and interest has not changed. But the huge amount of added debt to be taken on by BCE in the takeover will lower the chances that the bond obligations will be paid. So, the bonds have dropped in value.

Bondholders could choose to simply hang on and hope that they get all the promised interest and principal in the fullness of time, but this won’t work for people who want to sell bonds now because they need the money.

Many investors choose bonds over stocks for safety reasons. By this logic, they probably would prefer government bonds over corporate bonds if they understood the risks involved with corporate bonds.

Another lesson here is the need for diversification. Most investors understand the need to diversify stock investments, but fewer understand the need to diversify corporate bond investments. If Bell Canada bonds make up 2% of your portfolio, then the planned takeover has just been an annoying blip. But if they are 20% or more of your portfolio, the past several months have been stressful.

Whether you own stocks, bonds, real estate, commodities, or anything else, understand the risks of what you own and be appropriately diversified.