Glitzy Asset-Backed Bonds Not Hot
By Russ Wiles
David Bowie can sing all he wants, but most mutual fund managers aren't ready to invest in entertainers like him.
It has been nearly two years since Bowie sold $55 million worth of bonds backed by his music royalties. Since then, pop singers Nickolas Ashford and Valerie Simpson have jumped on the bandwagon, as have some notable songwriters like the Motown team of Edward and Brian Holland and Lamont Dozier.
These transactions have put celebrity bonds on the map as a small, new subcategory of "asset-backed securities." The celebrity deals, especially Bowie's 300-song transaction, have heightened speculation that Wall Street financiers soon will issue bonds backed by all sorts of things created by talented people --- books, movies, TV shows, patents and more.
Yet through it all, fund managers have followed the action like bored chaperones rather than star-struck groupies. They haven't bought into celebrity bonds at all, although some have nibbled at less-glitzy types of asset-backed securities.
"Everybody likes to talk about David Bowie securitizing his royalties, but that doesn't really have much to do with the main asset-backed market," said Tom Sontag, co-manager of the Strong Advantage Fund in Milwaukee.
David Pullman, the New York financier who masterminded the "Bowie bonds", as they're called, admits that fund masters aren't ideal buyers for these investments, partly because the IOUs aren't issued in sufficiently large quantities to support an active resale market.
Celebrity bonds haven't been sold directly to individual investors either. That has left insurance companies as the main source of demand.
"Mutual funds buy more standard types of assets," Pullman said. But he predicts fund ownership will grow because the interest is there.
Such optimism isn't unwarranted considering how new the market is for asset-backed securities. Today's financial curiosity may develop into tomorrow's portfolio mainstay. Even common investments like mortgage-backed bonds, money-market instruments and many types of mutual funds didn't exist a generation ago. So who's to say that asset-backed securities and even bonds pegged to celebrity royalties won't proliferate?
"I can see mutual funds owning larger pieces of these bonds, especially as they build up size and are included in some of the standard bond indexes," Sontag said.
Most asset-backed securities are tied to much less glamorous things than music, movies, TV shows or books. In fact, the majority are supported by various types of consumer borrowings like home-equity loans, car and boat loans, credit-card balances, student loans and even mortgages on vacation time shares.
Of these, IOUs pegged to home equity and related real estate loans dominate. They accounted for 36 percent of the nearly $200 billion in asset-backed bonds issued last year, according to First Chicago Capital Markets. Bonds backed by credit-card balances and car loans were next, each making up about 18 percent of the total.
Most bond mutual funds don't have any significant holdings in asset-backed securities, especially such exotic fare as the Bowie bonds. However, interest in asset-backed bonds has been rising.
"We're starting to see some funds hold between 5 and 10 percent of their assets in this area," said Eric Jacobson, an associate editor in charge of fixed-income investing, for researcher Morningstar Inc. of Chicago. "A few funds hold stakes of 20 percent or more."
Morningstar doesn't classify funds that own asset-backed securities as a separate group, so it's hard to track down precise numbers. But Jacobson says intermediate-term bond portfolios are the ones most likely to own these types of IOUs. Intermediate-term funds typically own a grab-bag of bonds coming due within five years or less.
Strong Advantage is one such fund that has jumped on the asset-backed bandwagon in a noticeable way. The fund has about 6 percent of its $2.8 billion portfolio invested in bonds pegged home-equity loans. The fund's investment parameters allow it to venture into car, boat, credit-card and other asset-backed bonds. But Strong's management team has shied away from doing so because the yields in these areas aren't as high as with real estate, Sontag said.
For example, Ford Motor Co. recently sold some auto-loan bonds yielding anywhere from half to a full percentage points less than comparable real-estate IOUs.
Certain other portfolio managers are shying away from securities because yields on more conventional bonds are relatively juicy. For example, managers of the Milwaukee-based Firstar Bond Immdex Fund have trimmed their weightings in auto- and credit-card loans to about 6 percent of the portfolio from 18 percent last year.
"We look at these as substitutes for mortgages and corporate bonds," said Gary Elfe, Firstar's director of fixed income research and trading. "But if we get back to an environment of a year ago (when yields were compressed on competing bonds), then we would go for the high quality that asset-backed securities provide."
Observers agree that asset-backed bonds are fairly safe. Despite rising personal-bankruptcy rates across the nation, the bonds have been well insulated against default, diversified as they are among hundreds or thousands of consumer borrowers.
Compared with conventional corporate bonds, few asset-backed IOUs have had their credit ratings downgraded by independent watchdogs like Standard & Poor's Corp. and Moody's Investors Service. "The credit history on this stuff has been terrific," Sontag said.
How Royalty Bonds Work When people read about bonds sold by entertainers, such as the $55 million deal put together by David Bowie, the first question that comes to mind is: Why? Why do celebrities choose to forsake future royalty payments for up-front cash? Why do they need the money? Why do investors buy these bonds? David Pullman, the New York financier who put together the Bowie deal, has the answers. First, he says, celebrities like the idea of receiving an up-front payment from a bond issuance because the money received is tax-free. It's basically a loan that the person pays back over 10 to 15 years through future royalties collected on songs, books or films. The money then can be invested at higher rates than the royalties are growing. There are other tax advantages, too. Also, the intellectual property backing the bonds typically will appreciate, or at least retain its value over time. "A car might be worth nothing after five years, but these songs will be worth something forever," said Pullman, managing director of the Pullman Group. The celebrity retains ownership of the underlying assets and begins to see cash payments again once enough royalties have been collected to pay off the bondholders. Meanwhile, investors typically receive a higher yield on celebrity debt than they can earn on comparable investments such as corporate bonds, Pullman says. Although there's a risk that a particular artist could fizzle. Pullman says the assets used as collateral are of good quality and have a steady track record. He emphasizes that celebrities pledge royalties only on existing products --- not songs, books or shows that they haven't created. |
The Arizona Republic, February 15, 1999.