Gross Joins Cruz in Hunt for High-Yield Debt as Treasuries Soar
Put Bill Gross, manager of the world’s biggest bond fund, and ex-Morgan Stanley President Zoe Cruz in the camp that sees investor demand for low-rated corporate debt even as super-safe U.S. Treasuries rally on concerns that the economy is slowing down.
Gross’s Pacific Investment Management Co. and Cruz’s Voras Capital Management LP were among at least eight firms telling regulators in June they are starting funds that may buy junk bonds and distressed securities. High-yield debt returned 1.32 percent last month, trailing the 1.81 percent gain for Treasuries, Bank of America Merrill Lynch indexes show.
U.S. government bonds have surged amid signs the economic recovery is losing momentum, pushing yields on 10-year Treasuries below 3 percent for the first time since April 2009. That’s making average junk-bond yields of about 9 percent attractive to investors willing to bet the U.S. isn’t heading into another recession.
“In the high-yield sector, you don’t really need an economic recovery,” said David Breazzano, who co-founded DDJ Capital Management LLC after co-managing distressed and high- yield assets for Boston-based Fidelity Investments. “You just need the economy to stay where it is, and you can get double- digit returns and you have less interest-rate sensitivity” than with Treasuries.
Concerns that the economic recovery is slowing were reinforced this week by a larger-than-expected decline in U.S. consumer confidence in June and smaller gains in China’s leading economic indicators during April. The yield on the benchmark 10- year government bond fell as low as 2.92 percent on June 29.
Investors pulled a record $6.3 billion from high-yield mutual funds during May, according to data from Chicago-based Morningstar Inc. Treasuries are considered ultra-safe because they are backed by the government’s ability to print money to repay its debts.
The spread between yields on U.S. bonds and corporate high- yield debt has widened as investors demand a higher premium to hold the riskier securities. Yields on the lower-grade corporate bonds are 7.06 percentage points higher than those on the 10- year U.S. bond, up from a 52-week low of 5.42 percentage points on April 26, according to the Merrill Lynch U.S. High Yield Master II Index.
Investors who are bullish on risky debt note that Moody’s Investors Service reported on June 6 that the global default rate for high-yield issuers declined to 7.5 percent in May from a peak of 13.5 percent in November, a sign that highly leveraged companies are weathering the economic turbulence. The New York- based rating firm expects the rate to fall below 2 percent by June 2011.
The spread between Treasuries and noninvestment-grade bonds, those rated below Baa3 by Moody’s and BBB- by Standard & Poor’s, would normally coincide with a much higher default rate, said Kingman Penniman, president of KDP Investment Advisors, a high-yield research firm based in Montpelier, Vermont.
“When you look at where spreads are today, there is no question that the high-yield market is oversold,” Penniman said. “Unless you are predicting a double-dip recession to happen pretty quickly, it would be pretty hard to get that default rate up there.”
Pimco, the Newport Beach, California, firm that Gross co- founded and helps run, filed with the U.S. Securities and Exchange Commission on June 15 to register the Pimco High Yield Spectrum Fund. It will be managed by Andrew Jessop, former co- head of the high yield at Goldman Sachs Group Inc.’s asset- management unit.
Pimco Total Return
Gross has been buying U.S. government debt, increasing it to 51 percent of his $227.9 billion Pimco Total Return Fund in May from 36 percent the previous month. For his personal portfolio, Gross disclosed in securities filings that he spent $8.1 million during May to buy shares in three Pimco funds that invest in bonds or bank debt issued by high-yield companies.
Mark Porterfield, a Pimco spokesman, declined to comment.
Cruz’s firm filed with the SEC on June 15 for the startup of Voras Global Liquid Opportunities Fund LP and Voras Credit Opportunities Fund LP. Once viewed as a possible successor to John Mack as Morgan Stanley’s chief executive officer, Cruz, 55, formed her New York-based firm to make macroeconomic bets and invest in distressed assets after being ousted as the bank’s co- president in November 2007.
She didn’t return a telephone call seeking comment.
Also filing for new high-yield funds last month were Shenkman Capital Management Inc. of New York, Millstreet Capital Management LLC in Quincy, Massachusetts, and Crestone Capital Advisors LLC in Boulder, Colorado. Firms starting credit opportunity funds, which can hold all types of debt, include III Offshore Advisors of Boca Raton, Florida, and 400 Capital Management LLC, a New York-based firm run by Chris Hentemann, who stepped down in October 2007 as head of global structured products at Bank of America Corp.
“It’s actually a pretty good time for some of these leveraged credits to outperform over the next several years,” said Craig Kelleher, co-manager of MillStreet Credit Fund LP, which disclosed in a June 25 filing that it’s seeking to raise as much as $100 million. “There are some good credit stories in the mid-tier segment of the market.”
In contrast, companies acquired through leveraged buyouts may continue to struggle because they have too much debt, according to Kelleher and his partner, Brian Connolly, both of whom previously worked at Regiment Capital Advisors LLC, a Boston-based firm that manages high-yield debt for Harvard University’s endowment.
“The market has come to be dominated by some of the large LBO names that are teetering on the edge,” Connolly said, adding that some of these companies have avoided default by exchanging debt for equity or stretching out maturities. “It’ll be difficult for them to generate enough free cash to delever meaningfully.”
That’s one reason some money managers have begun raising money for new distressed funds. These funds often buy high-yield bonds and bank loans that are about to default or have already done so, and then swap the debt for equity in these companies when they seek to cut their borrowings through a restructuring.
Breazanno’s firm, based in Waltham, Massachusetts, said in a June 15 SEC notice that it had received $56 million in commitments for the DDJ Distressed & Special Situations Fund LP, while New York-based GoldenTree Distressed Debt Fund LP reported June 25 that it had obtained about $31.7 million.
“A lot of the transactions we look at are these leveraged buyouts that occurred a few years ago,” said Breazzano. “Either their refinancing is attractive as a high-yield opportunity or they are unable to get the refinancing done, so it becomes a potentially attractive distressed opportunity.”
Doug Bonnette, a principal at Crestone, which filed documents for the Kenosha High Yield Fund III LP with the SEC on June 17, didn’t return a telephone call seeking comment. Scott Wyler, III Offshore’s general counsel, declined to comment on the III Credit Opportunities Fund LP.
Robert Matza, president of GoldenTree Asset Management, and Hentemann at 400 Capital didn’t return telephone calls.
Shenkman Capital Management filed June 14 for the Brevis High Income Fund LP. Richard Weinstein, an executive vice president at the firm, said the fund will seek to buy high-yield debt that has a short duration, meaning it is less sensitive to changes in interest rates.
“With money-market rates near zero, people are very concerned about prospects for higher interest rates,” Weinstein said in a telephone interview. “They are looking to hedge their bets by taking a short duration,” he said, adding that Brevis is the Latin term for short.
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