Investors should reduce their holdings of speculative-grade bonds going into the last three months of the year as yields on the notes hover near record lows, according to Morgan Stanley.
“Risk/reward for the asset class is less attractive today than at any other point this year,” analysts Adam Richmond and Jason Ng wrote in a report dated today. “The main driver of our downgrade is unattractive total return prospects going forward.”
Junk-debt funds recorded $3.63 billion of deposits in the week ended Sept. 19, the second-biggest volume ever, according to data compiled by EPFR Global, as the Federal Reserve said it expected to hold its target rate near zero for at least another three years. Yields on speculative-grade bonds in the U.S. fell to an unprecedented 6.95 percent on Sept. 19, according to Bank of America Merrill Lynch index data.
“Though spreads could tighten further, especially if rates rise, we think dollar prices are topping out,” the Morgan Stanley analysts wrote. Also, weaker economic data is putting pressure on the credit quality of speculative-grade borrowers, according to the analysts.
High-yield, high-risk bonds, graded below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, have gained 12.5 percent this year, Bank of America Merrill Lynch data show.