Biggest Buyers Stampede From Junk Bonds on Loss: Credit Markets
The biggest buyers of junk bonds are in retreat as exchange-traded funds suffer unprecedented withdrawals with the debt facing its first losses in eight months.
The outflows sent the combined value of the five biggest junk-debt funds down 7 percent from a four-month high in January to $29.8 billion, according to data compiled by Bloomberg. State Street Corp.’s $11.9 billion fund reported withdrawals of about $988 million in the 12 days ended Feb. 13, the longest stretch since August 2011.
A pullback three times bigger than that for mutual funds which cater to individuals suggests investors such as hedge funds and banks are cherry picking rather than investing in the broader market, said Peter Tchir of TF Market Advisors. Almost six years after the first high-yield ETF was created, the funds have been drawing the interest of institutions seeking rapid entries and exits with securities that traditionally were traded over the counter.
“Institutions are moving away from indexes,” Tchir, founder of the New York-based advisory firm, said yesterday in a telephone interview. “You’re seeing a real focus on the specific bonds.”
Investors who poured $8 billion into junk ETFs in 2012 when the securities gained 15.6 percent are fleeing as Morgan Stanley strategists predict the debt will return 3.1 percent this year, less than its coupon. Dollar-denominated junk bonds lost 0.4 percent in the week ended Feb. 6, when the funds reported an unprecedented $1.1 billion of withdrawals, according to Bank of America Merrill Lynch index data.
Prices are dropping from a record 105.9 cents on the dollar on Jan. 25 as concern deepens that values are unable to go much higher with interest rates rising from record lows and after four years in which average annualized returns reached 21.6 percent, compared with 3.6 percent losses in the preceding period.
Bond buyers from Loomis Sayles & Co.’s Dan Fuss to Oaktree Capital Management LP’s Howard Marks have said that the market prices are too high after investors funneled $20.9 billion into funds that buy speculative-grade debt last year, Royal Bank of Scotland Group Plc data show.
“The high-yield market rally had simply overextended itself going into December and January, and now the hottest trend-chasing money is making a withdrawal,” Oleg Melentyev, a Bank of America Corp. credit strategist in New York, wrote in a Feb. 8 report. “This most recent pullback signifies how unstable the market is becoming at its current valuations.”
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increasing 0.06 basis point to a mid-price of 86 basis points as of 11:02 a.m. in New York, according to prices compiled by Bloomberg.
The index typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.23 basis point to 15.11 basis points as of 11:04 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of H.J. Heinz Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 6.3 percent of the volume of dealer trades of $1 million or more, at 11:05 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The company, based in Pittsburgh, obtained $14.1 billion in financing from JPMorgan Chase & Co. and Wells Fargo & Co. to support the ketchup maker’s $23 billion buyout by Warren Buffett’s Berkshire Hathaway Inc. and 3G Capital, according to a regulatory filing today.
Fuss, whose Loomis Sayles Bond Fund beat 98 percent of its peers in the past three years, said last month that junk debt is “overbought as I’ve ever seen it,” while Oaktree’s Marks told clients in a January memo that “this is a time for caution.”
Yields on junk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, fell to a record low of 6.41 percent on Jan. 25, according to Bank of America Merrill Lynch index data. An unprecedented $72.4 billion flowed into junk funds globally last year, according to EPFR Global.
The Bank of America Merrill Lynch U.S. High Yield Index has lost 0.06 percent this month through yesterday.
The $1.1 billion of withdrawals from junk-bond ETFs in the week ended Feb. 6 compares with $324.1 million pulled in the same period from mutual funds, which manage $290.2 billion, according to RBS citing Lipper data.
The ETFs have lost $568.1 million of deposits this year while mutual funds reported $1 billion of inflows, the first directional divergence since the quarter ended Sept. 30, 2011, RBS data show.
That period 16 months ago “was a bad time for corporate credit,” said Bonnie Baha, the head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees about $53 billion. “Everyone agrees that valuations are ridiculous yet money has continued to flow into the sector.”
Investors put $211 million into non-ETF mutual funds that invest in high-yield bonds this week while pulling $540 million from junk-debt ETFs, according to a Feb. 14 Bank of America report.
The Federal Reserve’s policy of holding benchmark borrowing costs in a range of zero to 0.25 percent since December 2008 prodded investors to buy riskier assets as Treasury yields plunged to an unprecedented 1.39 percent on July 24 before rising to 2.03 percent on Feb. 13, the highest since last April.
Mutual funds and ETFs have been among the largest buyers of corporate bonds in recent years, credit strategists led by Stephen Antczak at Citigroup in a Feb. 1 report.
As a result, the corporate bond market has grown more vulnerable to losses that are accelerated by outflows when U.S. Treasury rates rise because “these buyers tend to be backward- looking and sensitive to total returns, particularly negative total returns,” they wrote.
ETFs are losing investors who are seeking better opportunities in specific credits as they see the diminishing potential returns for the broader market, Tchir said.
The disproportionate outflows among the ETFs compared with the mutual funds shows that the funds truly are “‘fast money’ and could leave quickly,” wrote credit strategists led by Eric Beinstein at JPMorgan in a Feb. 14 note.
“Institutional money in particular is moving out of these,” Tchir said, noting that the ETFs are typically restricted to buying the most-actively traded bonds from the largest issuers, which have benefitted disproportionately from last year’s inflows. “People are either shifting into the smaller issuers or those that don’t fit these indices particularly well.”
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