In 2009, the FASB (Financial Accounting Standards Board) changed GAAP accounting standards so that companies would have to record assets at mark-to-market value. This means companies need to record the unrealized gain or loss of a security as income (or loss) prior to ever selling the security. The implications of this accounting change are enormous. And that’s because it forces bond investors to liquidate in anticipation of falling coupon values, which in turn forces them to re-invest the capital into higher risk securities like BBB rated bonds and stocks. This enriches the portfolio of those that are willing to take on a bit more risk, like American International Group, Inc. (NYSE:AIG).
Alternatives
American International Group, Inc. (NYSE:AIG) is a compelling investment opportunity, but is it the best place for our money? Is there anything better? If you want to invest in a business like this, is there anything safer? Diversification is one of the most practical strategies to protecting capital.
The Travelers Companies, Inc. (NYSE:TRV) is an investment alternative you might consider. Recently, it has been able to increase its profit margins from 5.5% to 9.5%, partly because the company’s loss adjustment ratio fell by about 4% over the past could years. Analysts expect the company to grow earnings by 22% this year, and this optimism is backed by its 43% exposure to AAA rated bonds.
However, the problem with AAA rated bond securities is the sudden decrease in coupon values, which would translate into unrealized losses in mark-to-market accounting. This could damper the company’s earnings. On the flip side, bond interest rates generally don’t move very fast so the effects of this could be balanced by The Travelers Companies, Inc. (NYSE:TRV) collection of higher insurance premiums and cutting of costs.
On the other end of the spectrum, the Bank of America Corp (NYSE:BAC)’s exposure to mortgages with a rating below BBB is huge, as it composes 57% of the banks credit exposure. In an environment of rising interest rates and falling risk premiums, the value of this lending portfolio could appreciate in value. Despite this potential upside, Bank of America Corp (NYSE:BAC) is attempting to be more conservative.
Source: Bank of America
Like American International Group, Inc. (NYSE:AIG), the composition of Bank of America Corp (NYSE:BAC)’s lending portfolio is smooth considering today’s interest environment. The CEO, Brian Moynihan, is planning to sustain net income growth by cutting $8 billion in costs by 2015. In anticipation of these cost cuts, analysts anticipate it to grow earnings by a substantial sum over the next 5 years.
Conclusion
American International Group, Inc. (NYSE:AIG) and its exposure to below investment grade securities could be undervalued if higher risk assets continue to appreciate. Deflationary monetary policy is causing bond investors to unwind large bond portfolios in favor of higher risk assets. This plays into AIG’s strategy and its junk could make for a quality investment.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends American International Group, Inc. (NYSE:AIG). The Motley Fool owns shares of American International Group and Bank of America Corp (NYSE:BAC) and has the following options: Long Jan 2014 $25 Calls on American International Group.
The article Buy AIG’s Junk originally appeared on Fool.com.
Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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