Playing the Bailout: Bonds May Benefit Over Stocks

Corporate bonds—not stocks—could be the big investment winner as the government continues to pledge billions of dollars to bail out too-big-to-fail companies.

While shareholders often get no benefit from a government bailout—and sometimes even get wiped out—bondholders could see the value of their investments rise as the company recovers. And that could carry over to corporate bonds in general.


"It's very possible that if things work out, we're going to see equity-type returns in corporate bonds over the next couple of years and possibly with less risk than stocks," says Michael Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y. "That's simply because so many bonds have been super-repressed and not every company is in the financial trouble...That's leaving opportunity."

One company getting money directly from the bailout fund, American International Group , has become enticing for investors who are picking up the insurer's debt on the belief that its positions has been strengthened from the government money. The government has been funneling the money through its $700 billion Troubled Asset Relief Program, or TARP, that injects capital into liquidity-challenged institutions.

AIG said Monday it has reworked its deal with the governmentto get even more funding.

"I've seen some people buying the corporate debt of the banks that have been participants in the TARP," says Dennis P. Barba Jr., managing partner of the Oxford Group of Raymond James. "It's helped some of the the AIG subsidiary bonds. They've increased pretty dramatically in price the last 45 days. There's always opportunities."

General Motors may be another case. The flailing automaker, along with Ford and Chrysler, could get some kind of a government bailout in the coming weeks.

Watch a report on prospects for an automaker bailout in video at left.

But GM shareholders, who have already seen the stock plunge to about $1, aren't likely to benefit much. Instead, secured bondholders could be the prime beneficiaries not merely in GM, but in the surviving ancillary companies who would find themselves with new lives should the big automakers survive.

Moreover, a successful bailout program across board—for the automakers as well as large financial institutions—would ease the pressures on the economy. Investors buying corporate bonds at deep discounts now could reap big profits later.

Plenty of Peril

To be sure, there still will be considerable risk.

For his part, Kresh says he's not even ready yet to identify the particular companies whose bonds will present the best opportunity though he will be watching the automakers' situation most carefully and ancillary company

"We're spending a lot of time trying to look for individual issues, just looking at the marketplace so there's nothing significant in the portfolios that scares us," he says. "There's a lot of additional research work that has to be done in this market."

But the bargain-basement prices for corporate bonds are becoming less of a well-kept secret in the investment world.

For Investors

Yields are at Depression-era levels for lower-rated companies, according to a report Monday in Barron's, and are dwarfing returns on government debt. The trick, analysts say, is to find double-digit yielding companies whose prospects for the future look less risky than competitors.

"Those who survive are going to give very, very powerful opportunties for investors that are cherry-picking the right issues," Kresh says.

On the other hand, Barba warns that some investors may go overboard with snapping up corporate bonds, particularly in banks, and not have sufficiently diversified portfolios.

"You've got to be careful on the financial side so you don't blindly put money in debt instruments of financial institutions. If things remain ugly you're going to see some volatility on those issues," he says. "I just think you've got to be prudent in terms of diversity."

No Bailout for Stocks

There appears to be little immediate benefit to buying stocks of companies that will benefit from bailout money, primarily because their primary debt obligation will be to the government.

Deutsche Bank on Monday cut GM's price target to nothing, something Kresh says he has never seen before, and indicated that if the compay does survive it will trade as if it is bankrupt, leaving no value to shareholders.

There will be some companies that certainly will benefit, but probably not those who directly get the bailout funds. In China, the situation is different, where a stimulus plan calls for major investment in public works projects, benefitting companies who specialize in that realm.

"It's a very difficult question as to how to benefit from that," says Richard Sparks, senior analyst at Schaeffer's Investment Research. "It really comes down to whether you believe the money is going to help whether there's no amount of cash that is really going to help."

Sparks recommends staying away from stocks in bailout beneficiaries like AIG, and prospective recipients like GM and Ford, because of the general instability of the companies regardless of government help.

"For most people it's probably too much risk for the possibility that you would get a reward," he says. "Unless you're willing to acknowledge the worst-case scenario, I don't think that's a trade I would be willing to make."