Recent market moves have brought home the fact that volatility has not been cancelled in the income market. Fears of out-of-control inflation driven by the recent CPI print, alongside poor payrolls numbers, suggest that currently stretched valuations may be overly optimistic. In this article we take a look at one niche area of the market – pinned-to-par securities – which has remained relatively resilient over the last couple of days as macro surprises have buffeted asset prices.

You Say Pinned-to-Par I Say Call-Anchored

You have to love the terminology of income assets. Not only are they often obscure, but different wording can refer back to the same concept. In this article we look at those senior securities – preferreds or baby bonds – that are currently callable and are trading above “par” (or to be precise, liquidation preference for the pedants in the back row).

The fact that these securities 1) can be redeemed right now by the issuer and 2) a redemption can deliver a negative hit to investors (if you buy a stock at $26 and the issuer redeems it and hands you $25, you are out $1 out of pocket) generate some interesting and unusual dynamics.

First, because of the likelihood of redemption, pinned-to-par securities tend not to trade significantly above their “par” amount. Of course there are exceptions, but by-and-large, these securities tend to cluster at levels 1-4% above “par”. This has a knock-on effect that the yield on these securities is higher than it “should be”. In other words, if these securities weren’t callable, their prices would move significantly higher, reducing the yield available to investors. But because investor are not willing to bid their prices higher for fear of redemption, they can kick off yields above what the market would normally demand of a new issue.

Another consequence of this dynamic is that these securities are often locally resilient to higher rates and wider credit spreads. We say locally because, for large enough rises in yields, the prices of these securities are not going to defy gravity and they will move lower. But, for marginal rises in yields, they can maintain resilience.

The downside, of course, is that these securities can be called away by the issuer at any point, so legging into them requires some care in order to minimize the risk of loss on redemption.

Dynamics Of Recent Volatility

The chart below captures how these securities behaved over the last two days of rising yields (due to both higher Treasury yields and wider credit spreads). Across the majority of sectors, pinned-to-par securities (orange bars) outperformed the broader sector (blue bars).

Takeaways

Pinned-to-par securities have been relatively resilient over this recent mini sell-off due to their unusual dynamics. Although they can be redeemed at short notice by the issuer, holding a number of these securities reduces this risk and can generate attractive absolute and risk-adjusted returns for income investors.

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