A selloff in speculative-grade bonds is as much as four years away, according to Jeffrey Gundlach, manager of the top-ranked DoubleLine Total Return Bond Fund.
“Junk bonds will do OK,” Gundlach, whose Los Angeles-based DoubleLine Capital LP managed $56 billion as of March 31, said yesterday in an interview. While increasingly loose covenants, payment-in-kind bonds and other signs of froth are concerning, they haven’t “crossed the line,” he said. “The stresses aren’t there because rates are low, profits are high.”
This credit cycle has been stretched out after investor demand for corporate debt allowed issuers to extend maturities and refinance at lower rates, effectively bailing them out and delaying the next downturn by three to four years, he said. U.S. junk-bond yields fell to a record low 6.31 percent yesterday, down from last year’s high of 8.46 percent, according to the Bank of America Merrill Lynch U.S. High Yield index.
Federal Reserve Governor Jeremy Stein warned in February that he was seeing “a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit,” as more than four years of central bank stimulus push investors toward the riskiest securities. Gundlach, who correctly predicted the subprime mortgage crisis in 2007, said while he expects investors to lose enthusiasm for bonds, yields can stay low for a long time and interest rates aren’t poised to rise as the Fed maintains its policy.
Gundlach, who said in December investors should hold cash and wait to buy risky assets at lower prices, is hunting for the “fruit left on the trees,” securities that are “off the run,” for yields of as much as 7 percent and returns of as much as 10 percent for a “couple of years,” he said in a talk to investors yesterday at the New York Yacht Club.
Gundlach’s DoubleLine Total Return fund has grown to $40 billion since its 2010 inception. The fund advanced an annual 12 percent to beat 99 percent of peers over the past three years, according to data compiled by Bloomberg. Gundlach co-founded DoubleLine in December 2009 after he was fired from TCW Group Inc. over a dispute.
Speculative-grade, high-risk bonds, rated below Baa3 at Moody’s Investors Service and lower than BBB- at Standard & Poor’s, gained an average of 23.2 percent in the four years ended Dec. 31, 2012, and have returned 2.9 percent this year, according to Bank of America Merrill Lynch index data.
The trailing 12-month U.S. speculative-grade corporate default rate is expected to fall to 2.6 percent by the end of the year after finishing the first quarter at 2.9 percent, unchanged compared with a year ago, according to a report April 8 from Moody’s.
The Fed’s Stein said that the junk-debt market may be overheating in a Feb. 7 speech in St. Louis. If so, “it does not bode well for the expected returns to junk-bond and leveraged-loan investors.”
A measure of investor protection on North American high-yield debt averaged over three months deteriorated to a record low even as covenant quality improved in March, Moody’s said.
The average covenant score, in which 1 is the strongest covenant quality and 5 the weakest, worsened for a third period to 3.97 last month, according to Moody’s Covenant Quality Index.
Dan Fuss, whose Loomis Sayles Bond Fund beat 98 percent of its peers in the last three years, said in January in an interview in London that high-yield is more “overbought” than at any time in his 55-year career.
“This is absolutely, from a valuation point, ridiculous,” Fuss said.