In fact, fund managers have been demanding that companies include a significant yield hike after the first call date to give them safety that if the bonds are not redeemed. At least then their returns will match the new corporate yield reality.
Reliance did not include that and institutional investors stayed mostly away from it. But this was just the latest example of how savvier investors are shunning perpetuals without a significant step-up.
Similar notes from Chinese developer Agile Properties sold a few weeks ago at 100.00 are still trading around 95.00. Meanwhile, perps with step-ups are doing just fine.
"The argument to buy perps hinges on three things: absolute yield, rates direction and your bet on the company calling them or not at the call date," said one credit analyst.
Without the step-up, said investors, the perpetual has very little upside and a lot of potential downside. The lack of a maturity date means that the perps could behave like 30-year bonds. That means a significant potential drop in case benchmark rates rise. The longer the maturity on a bond, the bigger the price drop for every percentage point of yield rise.
On the flip-side, in the unlikely event that rates are lower five years from now, Reliance has the option to call the bonds and refinance them more cheaply, eliminating the upside for investors. "If rates collapse they can take the bond back," said a portfolio manager in Hong Kong. "It is entirely the company's prerogative to call them, which makes this deal very opportunistic," said the Hong Kong manager.
Besides the technical arguments, there is also the issue of what happens if Reliance does not call the bonds 2018. This problem was evidenced when Deutsche Bank did not call a lower tier 2 bond in December 2008. The decision caused the prices of similar bonds to drop up to US$10. It also sparked a 30 basis points widening in the European iTraxx subordinated financial index to about 237.5 basis points, while Deutsche Bank's subordinated credit default swaps widened by about 45 basis points.
Given the lack of incentive to call, Asian investors were predicting a similar outcome with Reliance. "Five years from now, imagine 30-year US Treasuries are at 5% and Reliance does not call the bonds, you will see the yield on their bonds jump to 8%," said another portfolio manager in Singapore who did not buy the bonds. "These private banking