America’s New Bond Underwriters Have Arrived in Search of Alpha

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The business of underwriting bonds is being turned on its head in the U.S.

Gone are the days when money managers would passively wait for Wall Street banks to pitch them deals. Now, they’re often the ones cooking up sale plans with corporate issuers, haggling over maturities and interest rates before taking them to the banks to finish off the transactions. The goal: Carve out and keep a chunk of the new debt -- a precious commodity in a market awash with cash after years of central banks’ easy-money policies -- before letting Wall Street distribute the rest.

It’s a transformation that’s been building since BlackRock Inc., the world’s biggest fund manager, brought in a former Bear Stearns Cos. banker to start a capital markets group five years ago, a hiring that helped mark investors’ intentions to drive more of the process. Babson Capital and AllianceBernstein Holding LP, among others, have since followed suit.

While the Wall Street banks still collect the fees on the bond sales, the shift underscores how they have ceded some of their influence in financial markets to the world’s top asset managers in the aftermath of the 2008 credit crisis.

‘Extremely Prevalent’

Precise -- and even imprecise -- estimates on how much of the nearly $1 trillion of U.S. corporate debt sales this year was initiated by fund managers are hard to come by, but traders, bankers and analysts all agree that these deals account for a growing share of the market. One recent example of a deal initiated by fund managers that produced quick returns: Fortescue Metals Group Ltd.’s $2.3 billion sale in April.

These transactions, known as reverse inquiries, “went from a weird, one-off type thing until now,” said Peter Tchir, head of macro credit strategy at Brean Capital LLC. “It’s become extremely prevalent and a tool that everyone is trying to use. It lets you have a little more control over what the issuance looks like.”

The initiative sprung up because the sales have become more critical than ever for fund managers. They provide access to bonds that can otherwise be hard to obtain; and can juice returns when prices on the debt rally right after the sale is completed -- a huge advantage in a market where a paltry 3 percent yield has become the norm.

Banks Retrench

A study carried out by Tchir, whose two-decade career in credit markets has included stints at UBS AG and Royal Bank of Scotland Group Plc, showed that a $168 billion pool of corporate debt sold in early 2014 added $1.5 billion of market value in the first 10 days after issuance.

The underwriting business provides a window into the changing landscape in the $39 trillion U.S. bond market. Much of the shift started with banks’ retrenching after new rules forced them to pare back risk in the wake of the 2008 crisis.

They cut thousands of jobs, leaving fewer veteran traders and bankers on bond desks, and, in the process, became less active in day-to-day market transactions. That often left their old clients, the money managers, to try to trade directly among themselves.

The push by fund managers into underwriting was a direct result in part of this Wall Street scale-back: If it’s going to be this difficult to locate and buy high-quality bonds in the secondary market, the thinking goes, then get them right from the primary source -- when they’re issued.

Over time, “banks started to lose a connectivity to these money managers,” said Michael Henderlong, who runs Babson’s capital markets group. “It gets to the point where the dealers have a tough time accessing all the different parts of the asset managers.”

AllianceBernstein Hire

Henderlong joined Babson, the $217 billion investment management firm that’s part of the MassMutual Financial Group, in 2013 after spending more than a decade at Morgan Stanley and Goldman Sachs Group Inc., two of the top ten underwriters in the U.S. corporate debt market. This month, Babson added John-Michael Chadonic, who’d previously worked at Bank of America Corp., to support the capital markets team by helping it understand who owns what and who’s selling what on Wall Street - - a task the biggest dealers once did.

At AllianceBernstein, which oversees $500 billion of assets, money manager Michael Sohr is responsible for holding constant talks with corporate-bond issuers and banks about new debt sales in the works.

Getting in Early

Once a sale is agreed upon with a company, a bank is found to distribute the bonds that the money manager won’t keep. Sometimes the transactions are private placements destined for only a handful of buyers; other times they’re broadly distributed.

“We want to get in there early and help structure it the way we want to,” said Gershon Distenfeld, who’s director of AllianceBernstein’s high-yield team. “Sourcing bonds had become increasingly important as it relates to the primary market.”

It’s not that this phenomenon is brand new.

The tradition of reverse inquiries -- money managers encouraging issuers to to sell a certain type of bonds -- is decades old. It’s just that it’s taking off now.

And for the investment firms, there are more advantages than just obtaining hard-to-find securities. They’re privy to more information than their competitors and are able to dictate terms that are most beneficial to them.

Like that time in April when Franklin Resources Inc. and Capital Group Cos. orchestrated Fortescue’s offering of junk bonds. Not only did their involvement ensure that they received a hefty slice of the debt, which carries an interest rate of just under 10 percent, it also allowed them to secure a greater claim on the Australian miner’s assets, people with knowledge of the matter said at the time.

The bonds, meanwhile, have already generated a hefty profit. In the two months since the sale, their price has soared 8.9 percent.

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