Puerto Rico:The Paradise Illusion

Puerto Rico might be a nice place to visit, but I wouldn’t want to invest there. If you think it might be a good idea to diversify and include some high yield junk bonds in your portfolio, Puerto Rico’s governor might give you reason to think again. In June 2014, Puerto Rican Gov. Alejandro Garcia Padilla signed a bill into law allowing the restructuring of $19 billion  of revenue bonds issued by commonwealth-owned electricity, water and highway monopolies.

You might have thought that debt secured by a particular stream of revenue might be safer than general obligation debt, but in this situation, you would be mistaken. When there is systematic failure of customers to pay their bills – in this case customers of large government entities – there is little likelihood that funds will be found to pay the debt. The new law, according to Moody’s, “provides a clear path to default for Puerto Rican public corporations.”

You may have thought you could diversify your risk by purchasing a high yielding mutual fund without looking inside the box. However, there is a lesson here for Muni bond investors.  Oppenheimer and Franklin Templeton Funds hold $1.7 billion of the electric company bonds, known as Prepa.

4 Responses to Puerto Rico:The Paradise Illusion

  1. Justin Smith January 12, 2017 at 7:04 am #

    Hi, just checking in and seeing if your views on Puerto Rico have changed or stayed the same as far as investment goes. Thanks,

    Justin

    • Hildy January 13, 2017 at 12:27 pm #

      Many of the able residents of Puerto Rico have come to the United States seeking employment. It is loaded with a huge amount of debt that it can never repay. The government must still take care of its inhabitants. I would not purchase their bonds now unless you like to ride a dangerous rollercoaster.

  2. Paulo September 30, 2015 at 12:24 pm #

    I mostly agree with the first post. Interest rates uulslay start to rise when the economy is doing better. When the economy is doing better then the companies that sold the junk bonds generally are more secure so the interest rates for junk falls or stays the same. And the higher yield becomes more attractive. But that only works for a while. When Fed starts raising rates high enough to slow the economy then junk gets hurt more because they more risky and generally more in debt. To simplify they perform better at first and worse later because you are weighing two factors, interest rates against default risk.

    • Hildy October 5, 2015 at 2:50 pm #

      As you said, buying junk or ‘high yield’ bonds is risky because you will probably want to head for the door when everyone else is trying to squeeze through, like the elephant who got his head past the door frame and is now stuck. That is why we recommend high quality bonds. We also recommend a self-liquidating buy and hold strategy so that you don’t have to try to fit through the door.

Leave a Reply