Yields are inversely related to prices and, whether you are dealing with bonds or shares, this is the inescapable rule which is drummed into all young advisers and traders. It’s mathematically set in stone; if the denominator (the lower part) of the fraction goes up, the fraction as a whole goes down.
So when you are advised the yield of something has gone up at the same time as the price, the natural inclination is to believe something is amiss. Yet, this is what has just happened with Alumina bonds. Alumina lost its investment-grade rating this week and slid from BBB- to BB, an event usually associated with investors losing out as the company is notionally more risky than previously.
However, bond issues often have clauses buried deep in the prospectus or PDS that state if a company loses its investment grade rating then the company will increase the coupon payable on its bonds.
This is what happened to Alumina. The credit rating downgrade triggered a step-up clause on the November 2019 notes so the coupon payable was increased by 5.50% to 7.25%.
Trading information in Alumina bonds is somewhat opaque as the bonds are not traded on an exchange, rather they are traded directly between principals: over-the-counter is the market term. According to one market maker for Alumina bonds, the yield to maturity increased from 4.48% to 5.68%. It is what one would expect when a company suffered a credit downgrade but what was unusual was how the market maker bid and offer prices also increased.
The explanation is not all that complicated. The coupon increased and once this was taken into account, even with a higher yield, the increase in interest payable to the holder meant the bonds were more valuable. Not that holders would want another downgrade; the terms of the bonds don’t allow for another step–up and, even if they did, another step up may not be enough to fully offset the additional risk.
In the 1970s there was advertisement for a type of Castrol oil and the slogan was “oils ain’t oils”. It is worthwhile for investors to remember this slogan because in the bond market “bonds ain’t always bonds”. Some bonds come with clauses which may be good, or bad, for investors and being informed of them prior to investment is a must.