High-Yield Hangover Hits Investors After Pound Bond Binge

Investors in sterling high-yield bonds are nursing losses after the busiest month for junk debt issuance in the British currency in 1 1/2 years.

Junk notes sold in July lost 3.3 percent on average, with bonds from U.K. supermarket chain Iceland Foods Group Ltd. down 4.4 percent and securities from restaurant chain PizzaExpress Ltd. falling 3.2 percent, according to data compiled by Bloomberg. About 2.3 billion pounds ($3.9 billion) of debt was sold during the month, compared with 800 million pounds in the period last year.

Investors, who have accepted some of the lowest yields in history as central banks suppressed benchmark rates, are starting to push back and demand the highest compensation in six months to hold sub-investment grade pound bonds. Sentiment is being hurt by the prospect of higher borrowing costs, intensifying turmoil in Ukraine and anxiety that a 70 percent drop in market liquidity will make it harder to exit positions in a selloff.

“We’ve seen some pretty aggressive selling of late,” said Stefan Isaacs, a fund manager at M&G Investments in London. “The large supply, coupled with concerns about rising rates in the U.K. relative to a benign environment for European rates, has weighed on sterling high yield. Geopolitical risks have also raised concerns and taken the shine off the market.”

Average Yields

The average yield investors demand to hold junk bonds in pounds has jumped 87 basis points to 5.7 percent, according to Bank of America Merrill Lynch data, the highest this year and up from a record low in May.

Junk bond buyers worldwide are pausing after unprecedented issuance in the first half. U.S. investors pulled more than $1 billion from exchange-traded funds that buy bonds last week following the biggest withdrawal ever from a short-term junk-rated ETF managed by Pacific Investment Management Co.

“Pricing and terms aren’t reflecting market conditions at the moment,” said Stephen Baines, an investment manager at Kames Capital, which manages about $88 billion. “That’s been reflected in how a lot of new issues have performed. We’ve said no to most new issues over the past month on either price terms or credit terms or both.”

Bond Losses

Buyers of pound bonds lost 0.4 percent last month, outpacing a 0.3 percent decline from euro-denominated notes while U.S. investors forfeited 1.3 percent, Bank of America Merrill Lynch index data show. Gains from sterling notes are still outstripping euro and dollar securities this year, handing buyers 5.1 percent.

Borrowers in the U.K. currency haven’t suffered as much as companies raising funds in the euro market, where four junk deals have been pulled in the past month as issuers cited adverse market conditions.

No sterling deals have been withdrawn during marketing. PizzaExpress got enough demand for its 610 million pounds of 6.625 percent and 8.625 percent bonds to cut borrowing costs by about 0.125 percentage points. Proceeds will be used to fund its leveraged buyout by Chinese private-equity group Hony Capital Ltd.

While growth in the U.K. makes a Bank of England rate increase more probable, a healthier economy boosts high-yield businesses. Standard & Poor’s forecasts Europe’s corporate default rate to decline to 4.1 percent next year from 6 percent in 2013.

Default Outlook

The benign outlook for defaults has encouraged investors to take more risk, buying 425 million pounds of notes rated seven steps below investment grade, or CCC+ and lower, this year, Bloomberg data show. That follows record sales of 475 million pounds of the lowest ranked debt in 2013.

The shift in sentiment is also hurting these notes, with bonds from U.K. budget clothing retailer Matalan Ltd. dropping 6 pence on the pound from a peak of 101 last month while notes from Phones 4U Ltd. fell 6 pence since the start of July to 83 pence.

“Performance has been rubbish over the past month,” said Andrew Wilmont, head of European high-yield investment at Neuberger Berman Group LLC in London, which has about $257 billion of assets under management.

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