News & Insights

Active Fixed Income Management: Why Call Structures Matter

The horror movie trope in "When a Stranger Calls" captures an unsettling realization from a babysitter, frightened by menacing phone calls, to then discover that her tormentor is already in the home. While the landline era is largely behind us, the core concept of this shocking reveal is parallel to the "call" features — or potential bugs — present in many corporate bonds today.

Unlike buying a call in equities, the call mechanism in bonds allows companies to call bonds before their final maturities at various set prices (or floating prices like make-wholes, which we’ll set aside here as they’re less relevant to this discussion). While some calls are tied to specific external events, for example a change in regulation that causes different treatment of the bonds, what we are focusing on here is the discretionary ones for companies. When a company issues debt, it loves the option, but not the obligation, to repurchase the bonds early. It is an option and options have value. In the current market with rates higher than they have been in recent times (though not too far off from longer run historical norms) these options should have even more perceived value to the issuing companies. A useful framework is heads they win, tails we (as investors) lose. Companies are likely to call bonds early if one of two primary things happen: The company’s business and capital structure improve, causing the spread and yield investors demand to come down, or rates as a whole move lower allowing for cheaper financing options. That is the exact sort of debt we as investors want to own, debtors that are now much better credits or debt that pays higher coupons in a lower interest rate environment (yield down, price up).

In theory, the call structure should come with investors demanding to be paid a price for giving companies that option to call bonds early, especially in an environment of higher rates. For high-yield bonds in particular, investors should receive even greater compensation given the higher probability of a material change in the underlying credit to the positive side. Instead, the situation we find ourselves in is spreads (or risk compensation) for high yield is extremely low and calls seem to be getting more aggressive by the day. Callable bond structures include 8NC3, which is an eight-year bond callable after three years; 5NC2 and 7NC3, both issued by a single B-rated issuer; and 3NC1, seen in a recent CCC-rated new issue. Those are examples from just one week; heads they win, tails we lose. If the CCC issuer has great performance in a year, congrats! You got one year of yield and a small premium. Not so bad, but a three-year bond would’ve been even better. On the other hand, if things go poorly, you are owning that worse credit risk and losing value.

It is at this point a question is probably asked: Why does this matter? The market has spoken, and investors aren't demanding much compensation for these call structures. It would be foolish for companies to not take advantage. The significance is active investing shines in a market increasingly dominated by passive strategies—where bonds are bought simply because they're index-eligible, without regard for their call features—there's an inherent opportunity to try to exploit these inefficiencies. An active manager can focus on finding older bonds that have fewer call features, or at the very least be conscious of their inclusion in the portfolios and the opportunity cost of them being called. It is unlikely to push back on the issuers (at least while the times are good, like right now), but there are many fish in the sea with different structures and it is an important characteristic in the current environment.

The call may be coming from inside the house, but you don’t have to answer unless you want to.

About Frost Investment Advisors, LLC

Frost Investment Advisors, LLC, a wholly owned subsidiary of Frost Bank, one of the oldest and largest Texas-based banking organizations, offers a family of mutual funds to institutional and retail investors. The firm has offered institutional and retail shares since 2008.

Frost Investment Advisors' (FIA) family of funds provides clients with diversification by offering separate funds for equity and fixed income strategies. Registered with the SEC in January 2008, FIA manages more than $4.8 billion in mutual fund assets and provides investment advisory services to institutional and high-net-worth clients, Frost Bank, and Frost Investment Advisors’ affiliates. As of June 30, 2025, the firm has $5.3 billion in assets under management, including the mutual fund assets referenced above. Mutual fund investing involves risk, including possible loss of principal. Current and future portfolio holdings are subject to risks as well.

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This commentary is as of Aug. 8, 2025, for informational purposes only and is not investment advice, a solicitation, an offer to buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as of the date given and are subject to change without notice. The information presented in this commentary was obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and cannot protect against losses in a declining market. All indices are unmanaged, and investors cannot invest directly into an index. You should not assume that an investment in the securities or investment strategies identified was or will be profitable.

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