Buyer beware: why it pays to be cautious when selecting bonds for a portfolio
The losses suffered by Australian investors in a bond issued by Virgin Airlines underlines the importance of conducting extensive due diligence before investing in any issue.
The misfortunes of investors in a bond issued by Virgin Airlines in Australia in 2019 exemplify just why the Australian Bond Exchange (ABE) places so much importance on examining the financial health of the underlying issuer and only chooses the highest-quality bonds for our platform.
Flying into trouble
The five-year Australian dollar bond, listed on the Australian Securities Exchange, paid an 8% coupon and appeared, superficially at least, to be extremely attractive. Indeed, the issue was in high demand and some of our clients expressed interest in the instrument.
The prospectus, issued in November 2019, highlighted that the company had suffered losses over the previous three financial years and outlined how it planned to return to profitability through cost-cutting and restructuring.
We applied our standard selection process to the Virgin bond. It included:
- An initial review of the bond to determine if it was likely to meet ABE’s exacting admission requirements.
- A detailed assessment of the issuer and the product using the product documentation and any other relevant information about the issuer.
Our selection progress – reviewed by an internal product committee – determined that the product was too risky, and we did not admit it to our platform. The outbreak of the COVID-19 pandemic in 2020 validated that assessment.
Airlines across the world shut down operations following the imposition of lockdowns. Many airlines survived the crisis. However, due to Virgin Australia’s weak financial position and the refusal of major shareholders – all airlines themselves – to provide financial support, it entered voluntary administration.
Heavy losses
The Australian Financial Review reported that “countless” numbers of small retail investors had used their self-managed super funds to invest in the bond. They faced heavy losses, and in August 2020 Virgin’s new owner, Bain Capital, confirmed that unsecured creditors – including bondholders – would receive between 9 and 13 cents on the dollar for their bonds. So, out of every $1000 invested, each bondholder would receive only $90 to $130 back.
That in a nutshell explains why we are so careful when selecting bonds for our platform. Not every bond is the same and it is vital to carefully check under the bonnet, because even bonds issued by household names can prove a trap for the unwary.
Disclaimer: This article contains general advice only. You need to consult with your independent financial, tax and/or legal adviser, and consider your investment objectives, financial situation, and your particular needs prior to making an investment decision. Australian Bond Exchange Pty. Ltd. and its authorised representatives does not accept any liability for any errors or omissions of information supplied in this document except for liability under statute, which cannot be excluded.