Stick to mutual funds until hybrids prove worth

STAYING AHEAD

September 12, 1994|By JANEE BRYANT QUINN

NEW YORK -- My view of any novel investment created by Wall Street is: Watch and wait. Don't be your broker's guinea pig. No one knows how any new security will behave when the stock or bond market takes a hit.

These thoughts arise from the introduction of what sounds like a pretty interesting offer to investors seeking income. It's a higher-yielding taxable corporate security that's mostly like a bond but a little like a stock. Wall Street calls it a MIPS -- for "monthly income preferred security."

A MIPS is like a bond in that it pays fixed dividends. But corporate bonds are typically sold in $5,000 lots (that's a minimum purchase of five $1,000 bonds). MIPS, by contrast, cost only $25 each. So they open this market to more individual investors.

But unlike a bond, the dividend on a MIPS can be temporarily suspended if the company runs low on cash. In this regard, it's like a preferred stock, which also pays an attractive dividend. The new MIPS that are coming out can suspend your payments for as many as five years -- although the company would first have to quit paying dividends on its common and preferred stocks. That gives MIPS investors some protection.

MIPS pay dividends monthly and offer yields around one-eighth to one-quarter of a point higher than those on comparable bonds. Compared with preferred stocks, MIPS pay a quarter-point to a half-point more, says Daniel J. Campbell, managing director of Merrill Lynch.

Since last October, 17 companies have sold $2.7 billion worth of MIPS, according to Christopher Hogg, the vice president at Goldman, Sachs who invented the security. Another 11 companies have $3.8 billion waiting in the wings. Among the MIPS issuers with higher safety-and-soundness ratings from the independent bond-rating rating agencies: Texaco, Capital Holding (a reinsurance company) and Corning. Aetna is readying a $500 million issue for sale.

The higher-rated MIPS have recently been priced to yield in the 6 percent range. Lower-rated companies offer returns that are even more alluring. PECO Energy's MIPS, rated BBB, paid 9 percent in July. (The ratings agencies rate MIPS as if they were preferred stocks. An A-rated MIPS is a little riskier than an A-rated bond.)

Typically, MIPS promise you five years of fixed interest payments. After that, the company can redeem the MIPS for the price you paid (which would probably happen if interest rates drop).

So there's the offer: an attractive interest rate at a low share price with modest to minimal non-payment risk. What's the catch?

Catch one: These hybrid bonds stand last in line if the company goes broke. All other creditors would be paid before MIPS holders got a dime. Not many large companies fail, however, so this is an outside risk.

Catch two: More lower-rated companies are coming to market. These pay especially high rates but have a greater chance of suspending dividends than A-rated issues.

Catch three: If the company does suspend payments, the money you're owed is credited to your name and will compound. You owe taxes on those built-up dividends, even though you don't get them in cash. For this reason, you might want to keep MIPS in a tax-deferred retirement account, even though they're sold as instruments for current income.

Catch four: One reason that MIPS pay higher dividends is that they're a corporate tax fiddle. Because of the way MIPS are issued, the company can tax-deduct the dividends, which wouldn't be possible if these were stocks. The IRS, however, might not approve of these schemes. If so, the companies can revoke the MIPS and return your money or exchange them for regular bonds.

Catch five, and the main reason not to become a MIPS guinea pig: MIPS don't mature for 30 to 100 years. So effectively, there's no date in your lifetime when you're guaranteed your principal back. When you want the money, you will have to sell on the open market. And no one has a clue what price MIPS will bring.

Hogg foresees no problem. But small amounts of MIPS might have to be offered at a discount. That could wipe out the advantage of higher interest rates.

Keith Foley, senior vice president of Fitch Investors Service, says that individuals will increasingly be offered hybrid investments like MIPS. But watch and wait. Mutual funds are better, until the hybrids prove their worth.

Jane Bryant Quinn is a syndicated columnist. Write to her at: Newsweek, 444 Madison Ave., 18th Floor, New York, N.Y. 10022.

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