Yields on speculative-grade bonds are justified by expectations for the economy and the ability of companies to meet their debt obligations, according to BNP Paribas Asset Management’s Martin Fridson.
Junk bonds have gained 8.7 percent this year after returning a record 57.5 percent in 2009, according to Bank of America Merrill Lynch’s U.S. High Yield Master II index. The extra yield investors demand to own the debt rather than Treasuries has declined to 682 basis points, or 6.82 percentage points, from 727 basis points on June 11, index data show.
The high-yield market assigns a 32 percent chance that the economy will fall back into recession, in line with estimates from Goldman Sachs Group Inc. and Pacific Investment Management Co., according to Fridson, global credit strategist at BNP Paribas Asset Management in New York.
“If investors are content to be compensated for a probability that credible observers at the leading financial institutions in their respective categories think is reasonable, it does not demonstrate that investors are in need of a psychiatric examination,” Fridson said today in an e-mail.
Spreads on high-yield debt, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, are above the average of 598 basis points from 1980 to 2009 and have increased from 246 basis points in May 2007, he said in a telephone interview.
“The notion that investors are recklessly ignoring risk seems hard to support, on the face of it,” said Fridson, who began his career as a corporate debt trader in 1976. “Especially considering that the default rate is considerably below its long-run average.”
Speculative-grade companies defaulted on their debt at a rate of 5.5 percent in the 12 months through July, down from a peak of 13.5 percent in the year ended November 2009, according to Moody’s. Defaults may fall to 2.6 percent by the end of 2010 and to 1.8 percent next year, the ratings company said.