Crypto and meme corporate bonds can go their own way

The author is a fixed income portfolio manager at Barksdale Investment Management and co-author of “Undiversified: The Big Gender Short in Investment Management.”

The collapse of some of the standard-bearers of the stock bubble in recent years has been painful for investors. We saw “pandemic winner” Netflix plunge 75 percent from 2021 peaks, crypto exchange operator Coinbase down 86 percent, and former meme stock and movie theater chain AMC down 80 percent.

Less attention is paid to the losses on their bonds. The damage done there is more moderate and is offset by coupon payments - a Netflix bond due in 2030 is down 19 percent from recent highs, a Coinbase 2031 bond is down 36 percent and an AMC 2026 bond is down 19 percent. This is partly due to the very different capital structures of individual companies and the risks of bonds compared to stocks.

For hedge funds that profit from arbitrage trades across capital structures, such differences provide a playground of opportunity. But the gaps also highlight differences in the ownership and return characteristics of stocks versus bonds.

First, although most investment-grade issues are publicly registered, the base of corporate bondholders is largely institutional. The publicly registered junk bond is a species in danger of extinction as onerous disclosure requirements and longer time-to-market push companies toward private placements with institutions. While institutional investors can trade frequently, the day trader concept and the associated increased volatility in stocks is largely a retail phenomenon.

Second, it's obvious that the return prospects for non-performing bonds and stocks are different, but the math is a little more nuanced.

Bondholders' downside risk, like that of shareholders, is unlimited if a company fails (although in practice unsecured creditors get back an average of 35 cents for every dollar invested in a failing company). But our advantage is limited. Bond documents typically contain a provision that says a company can redeem (or call) a bond before maturity and issue new debt at a lower interest rate, meaning the investor won't necessarily benefit much from an improved balance sheet.

That means the sky-high growth projections that have driven shares of Netflix, Coinbase and AMC to their all-time highs simply can't be priced into their bonds. Creditors still suffer from miscalculation, but the tyranny of limited upside saves us from ourselves when growth seems infinite.

Finally, corporate bond performance must be broken down into total and excess returns. The latter refers to the bond's return after comparing it with what investors could earn with "risk-free" government bonds of similar duration.

So what story do Netflix, Coinbase and AMC bonds tell? The “excess yield” on the Netflix bond due 2030 is about minus 7 percent compared to its peak in November. This means that more than half of the negative return has to do with the bear market in US Treasuries. Coinbase's 2031 bond, on the other hand, had a negative excess return of 28 percent since November, compared to a negative excess return of 5 percent for its index benchmark. AMC's excess return from its June 2021 peak was minus 14 percent.

The bond market seems relatively more comfortable with Netflix's financial strength. Coinbase's 2031 bond, on the other hand, reflects the skepticism that has persisted since its issuance last September. Unusually, the bond traded below par almost immediately - even though the stock and the Bloomberg Bitcoin Index didn't peak until November. It's not necessarily that creditors were ahead of the game in predicting crypto's recent selloff - rather, we don't have the stock-like mindset required for the crypto bull market embedded in Coinbase's top shares.

Finally, AMC strengthened its financial position through capital increases as its shares rose sharply. But its bonds with a first lien, or claim on company assets, trade at a large premium to debt compared to a second lien. This indicates ongoing concerns about the company's financial prospects.

Who knows where these companies' bonds will be in a year? But the plunge in the companies' shares raises questions about the logic of rules that allow individuals to buy shares of Coinbase or AMC, but not their unregistered bonds, to "protect" novice investors.

Barksdale Investment Management can hold stakes in the companies mentioned