Monday, May 11, 2009

Microsoft now a defensive play?

As an additional sign that the credit markets have not collapsed, the biggest and most historical software company of them all is offering its first debt issue.

This is an excellent example of the opportunities and frustrations that retail bond customers face.


You read this article in the morning, and as the defensive investor the idea springs to your mind:


"I've always wanted to get a bit of the action from the Microsoft business, but the stock has done horribly these past few years and I'm too conservative, even with my speculative investments, to ever purchase common equity in the company I will likely use every day for the rest of my life."

"The currency risk was always too much to deal with to make the stock an attractive investment after the tech Bubble burst"

"Now that they have issued so many billions of dollars in bonds, I can grab an AAA-rated investment that yields interest of a full percent above federal bond rates of similar maturity, that's a good deal!"

"I should be able to call my broker, or I can use my discount brokerage to purchase some units... oh joy!"


So here is the sad reality, why some people are turned off from the Canadian bond market, and what you should do as the DIY Canadian investor.


  1. When Microsoft issues this debt, they have already arranged for ALL of the billions of dollars to be purchased the moment it is issued.
  2. This works the same way that underwriters work for IPOs. A very large financial institution (or a group of financial institutions) will put up the entire cash amount up front to Microsoft, who then has an additional 2 billion dollars of capital to play with. Microsoft is then responsible for paying the interest on this capital and returning the full amount on maturity
  3. Once the major financial institution(s) have the bond issues in their possession, they will create a secondary market for them.
  4. First, they will sell the bonds (with a slight mark-up to pay for overhead and sales commission) to institutional investors (these investors include pension funds, insurance companies, government investment funds, even smaller financial institutions).
  5. Once the institutional investors have had their fill (the big boys eat the meat, the little guys get the scraps) they will retain the left-over bonds for you, the retail investor.
  6. By the time you get to purchase these bonds, if you ever do, the mark-up, and fluctuation in price could reduce the spread above a treasury note of similar length to zero.

What does all this mean?

It means that if you follow the news about debt issues, you are likely to be disappointed. What is more important is following trends in interest rates (which typically reveals where in an economic cycle you find yourself). Specific companies are not the primary focus of the bond investor- assets, debts, revenue and expenses are the primary concern of the savvy bond investor.

The FP article is interesting because Microsoft has never had to issue bonds (maybe they're starting to run out of money) and the article points to the resiliency of the investment-grade corporate debt market throughout the financial crisis (this strength has been widely overlooked, I do my best to change that).

But this story is very little help if you are trying to establish your diversified bond portfolio. If you lack this insight into the bond market in Canada, your first reaction is probably disappointment

The bigger picture is that when the corporate bond market grows (with the highest-rated corporations, like Microsoft leading the way) it encourages every single competitor to do the same. This has the net result of increasing the yield offered to investors (both institutional and retail) in an attempt to lure more capital.

I asked Hank Cunningham, the sagely author of In Your Best Interest: The Ultimate Guide to the Canadian Bond Market, what the retail investor should do if they missed an opportunity to purchase an attractive yielding bond.

The appropriate response is simple: wait for another investment grade corporation to have a new bond issue. So long as there are investors seeking the reliability and solid return of corporate bonds, there will be investment grade companies that are more than eager to meet that demand.

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