I have recently written a couple of articles for LearnBonds.com about the exchange-traded debt of two utilities companies. Those bonds, tickers DUKH and PPX, were issued by Duke Energy and PPL Capital Funding (subsidiary of PPL Corporation) and are junior subordinated debt. What exactly is exchange-traded debt, and how is it similar to or different from other bonds?
Exchange-traded debt is a type of bond that, rather than trading over-the-counter, trades on an exchange. When examining the features of many exchange-traded bonds, investors will notice that they seem to be a hybrid of preferred stocks and more traditional bonds. Some of the features worth noting include:
- Unlike traditional bonds, shares of exchange-traded debt do not have to be purchased in increments of $1,000. Furthermore, there are no minimum purchase requirements. When purchasing from a dealer in the traditional bond market, it is not unusual to have minimum purchase sizes as large as $25,000. In some cases, the minimums are significantly higher.
- Despite exchange-traded debt being a bond, when buying or selling shares, retail brokers will charge equity commissions rather than fixed income commissions.
- When buying exchange-traded debt, I like to place my orders one penny above the bid (rather than at the offer). In the traditional bond market, the chances of an investor getting filled on a retail-sized buy order placed at or near the bid are basically zero. In the world of exchange-traded debt, however, I have had significant success getting buy orders filled on the bid (your order becomes the bid price after placing an order just above the original bid).
- Exchange-traded debt differs from most (but not all) traditional bonds in that it pays distributions quarterly instead of semiannually.
- As a result of exchange-traded debt being a debt security, distributions are taxed as ordinary income. Many preferred stocks qualify for the more favorable dividend tax rates.
- Exchange-traded debt securities have maturity profiles that are typically very long-term (in some cases, much longer than 30 years). That makes them different from many traditional bonds (maturities for most companies do not extend beyond 30 years) and from preferred stocks, which usually do not have stated maturity dates.
- Some exchange-traded debt securities allow for the deferral of interest payments for a number of years. This is something you might come across when examining preferred stocks but will not find with more traditional bonds. Furthermore, unlike with a preferred stock, you will find examples of exchange-traded debt securities that accrue interest on the deferred interest (essentially making them zero-coupon bonds).
- Unlike many preferred stocks, in the event of a takeover, exchange-traded debt cannot be converted into shares of common stock. Moreover, unlike traditional bonds, a change of control provision is something you are not likely to come across in the prospectus of an exchange-traded debt security.
- Exchange-traded debt is higher up the capital structure than preferred stock.
- If you come across a senior unsecured exchange-traded debt security (unlike DUKH and PPX), do not be surprised if the call features are less attractive than the call features of a more traditional bond.
Investors looking for higher income opportunities than many traditional bonds offer and looking to avoid the volatility of the stock market often turn to preferred stocks. But exchange-traded debt may provide similar income opportunities and shouldn’t be ignored.
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