Many income-conscious savers and investors have had a rude introduction lately to a phenomenon known as "takeover event risk."
Until recently, owners of corporate bonds or bond mutual funds had just two main perils to consider.The first was credit risk, the chance that an issuing company might fall on hard times and find itself unable to pay interest on schedule or repay the principal when its bonds matured.
Credit risk can be minimized by limiting yourself to bonds of top-quality companies, as measured by their credit ratings and reputation, or by investing in a mutual fund with a widely diversified bond portfolio.
The second was market risk - the possibility that increases in inflation and interest rates would depress the market value of all outstanding bonds. This concern could be mitigated if you bought bonds with a firm intention to hold them to maturity, when they would be paid off at face value.
Now, thanks to the spreading popularity of leveraged buyouts, there is a third hazard to consider.
Even if a company is prospering and interest-rate conditions are benign, its bonds can fall suddenly in value if a buyout is proposed that would load the business down with new high-yield, or "junk bond" debt.
In the face of huge new buyout proposals lately for companies such as RJR Nabisco, diversification within the corporate bond market wasn't much help. Most corporate bonds fell amid the growing perception of takeover risk.
The investing institutions that dominate the bond market have raised loud protests, and a few recent bond issuers have attached provisions to their offerings providing holders with some protection in the event of a buyout.
In the meantime, what should individual investors do about this situation?
Avoiding takeover event risk is relatively simple - put your money in something other than corporate bonds where a takeover is impossible or at least unlikely.
"Consider event risk, and suddenly predictability isn't boring any more," declared one investment firm in an advertisement this week touting securities of federal government agencies.
U.S. Treasury securities are safest of all from takeover risk, just as they are from credit risk. For mutual fund investors, there are numerous funds that limit themselves to government securities.
Analysts at Standard & Poor's Corp. point out that some types of corporate bonds remain unlikely to be threatened by takeovers.
"Generally safe to buy are the bonds of the nation's largest corporations -examples are IBM, Exxon and DuPont," S&P said in its weekly publication The Outlook.
Most banks and regulated utilities, while they may become involved in other types of mergers, are also regarded as improbable candidates for leveraged buyouts.
If you want to switch money out of a corporate-bond investment to something else not affected by buyout risk, S&P suggests you might want to take action before yearend if your tax circumstances warrant doing so.
Any loss you realize can be used to offset capital gains you might have to report.
Beyond that, up to $3,000 in losses can be written off against your other income. If your overall loss is greater than $3,000, the balance is carried forward to future years.