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Re: [sharechat] Capital Notes

From: "" <>
Date: Thu, 30 Jan 2003 13:14:36 +0000

Hi Pat,
> I'm considering some good quality capital notes (e.g., Nuplex's, Sky
> City, Fernz, Transpower) as an option for the fixed interest portion
> of my portfolio.  Apart from the obvious risk associated with coupon
> payments and capital repayment (which would be proportionally
> similar to the risk of having a term deposit with any bank) 

Stop right there.  A capital note is with a single company.  This 
means it is reliant on quite a narrow sector of the overall business 
market to repay both your capital and the interest.  This is a higher 
risk investment than putting your money in the bank.  Quite 
respectable companies can collapse which will leave you out of 
pocket (what was the Skellerup Group a few years back is an obvious 
example ).  

Due to capital adequacy requirements and the fact that banks tend to 
be invested across the complete range of business and home sectors 
etc., any loss of capital or interest is much less likely to happen 
if you invest in a bank term deposit.

The problem with capital notes in NZ is that there really isn't a 
good system for judging the quality of them.  So what is a good 
quality capital note?   Is something from a company that you have 
heard of good enough?  Sometimes a company can set a capital note 
rate low to try to give the impression the risk is lower than it 
really is.   Often the secondary market for capital notes is the the 
place to spot these higher risk capital note investments.   Advantage 
Corporation capital notes had a coupon rate of 10% for example, but 
on the secondary market they are untradeable.  In other words the 
true risk is way higher than that implied by the bond coupon rate.

I've looked at getting back into the capital note market at various 
stages myself, but so far I haven't been able to make the numbers 
stack up.  The 'problem', if you want to see it that way, is that 
there are so many high yielding head shares on the New Zealand market 
with good prospects that taking the risk of locking your money into 
lower yielding capital notes I find hard to justify.  In the US, 
finding good quality high yielding shares is much harder and that 
makes the market for capital notes much higher profile.

A selling point of capital notes is that they rank ahead of 
shareholders for repayment of capital should a company collapse.  
This is true, but they also rank behind the banks.   The 
'safer investment' argument would have more sympathy from me if I 
could think of a single case where a company has collapsed and the 
capital noteholders have got their capital back when the 
shareholders didn't.  The banks always come out best from these 
situations leaving the capital noteholders with, in practice, a 
similar risk profile to the shareholders, but without the upside risk 
of sharing in improved profits.

So I would have to ask myself the question:  Why would I invest in 
Sky City Notes when I could invest in Sky City shares on a very 
similar yield?  I'd make the same argument for Nuplex and Nufarm 

Of course the shares may have a more volatile ride on the way to 
their higher expected return.   But capital notes will go up and down 
in value as well, so you don't get away from the volatility of your 
investment if you buy them.  And if smoothing the volatility is your 
goal perhaps another way of going about things is to invest half the 
money in bank deposits and the rest in high yielding head shares.

> is there any other important consideration/disadvantage 
> that I should take into account?
Buying capital notes when they are trading at above their coupon rate 
will mean you are subject to capital gains tax on the extra 
capital you get back when the notes mature.


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