- Pipeline bonds paid off well for AB, Federated in quarter
- Downside may exceed upside for high yield for rest of year
The best U.S. junk bond managers last quarter bet on energy companies as oil prices showed signs of recovery after plunging to their lowest level in more than a decade.
The AllianceBernstein Global High Income Fund, the best performing speculative-grade fund with more than $1 billion of assets, invested in the debt of pipeline companies, which are safer than drillers because they usually have long-term contracts to move oil and gas. Prices on those bonds were whacked in January and early February as crude prices fell before rebounding.
"We bought some of the very beaten up bonds," Gershon Distenfeld, AllianceBernstein LP’s director of high-yield, said. "Timing is always hard but you have to be willing to go against the grain." AB Global High Income is a closed-end fund, and a chunk of its gains came from its trading at smaller discount to net asset value.
Mark Durbiano, who manages Federated Investors Inc.’s open-end Federated Institutional High Yield Bond Fund, the fourth-best in the first quarter, also looked at pipelines, citing the companies’ relatively stable cash flow.
"That rebounded nicely for us in the first quarter," he said. The fund kept low holdings in energy drilling and metals companies relative to its benchmark, he added.
One issuer Durbiano liked was Crestwood Midstream Partners. Since February 11, the company’s 6 percent notes maturing in 2020 have rallied by 17 cents on the dollar to 79.95 cents.
Oil prices have oscillated wildly in recent months, taking junk bonds along with them. Crude fell till mid February, and has then rallied by more than 45 percent. When the dust settled, high-yield notes gained 3.25 percent in the first three months of 2016, their best quarter in more than two years, according to Bank of America Merrill Lynch index data. March’s 4.42 percent increase was the best month since October 2011.
“It’s been a white-knuckle environment,” said Dan Heckman, fixed-income strategist at U.S. Bank Wealth Management, which oversees about $127 billion in Kansas City, Missouri. “The stabilization in the price of oil has been the biggest help to the high-yield sector. But the market is still very vulnerable.”
That vulnerability has been clear in the new issue market. Western Digital Corp. cut its planned junk bond offering, part of the $14.1 billion of debt it needs to finance its purchase of SanDisk Corp., to $5.225 billion from $5.6 billion. High yield issuance has picked up in recent weeks, but is still anemic by historical standards -- sales for the first quarter fell 54 percent from last year’s levels, and were the lowest since the first three months of 2009, during the financial crisis.
Rising With Energy
If the price of oil rebounds and the economy grows, junk bonds could take off again, said Rick Raczkowski, the co-money manager of Natixis Loomis Sayles Core Plus Bond Fund.
“We’ve been positioning the strategy to favor credit risk over interest rate risk,” Boston-based Raczkowski said. “There’s been an emphasis on industrials and bonds related to energy. Oil prices will stabilize and move higher over the course of 2016.”
Some strategists and fund managers cautioned that junk bond prices may well fall later this year, and the potential upside is limited.
"This rally is a headfake," said Bonnie Baha, who helps oversee $95 billion at DoubleLine Capital.
Companies’ earnings prospects seem to be getting worse, not better. Analysts expect profits for companies in the Standard & Poor’s 500 index to fall 9.3 percent in the first quarter. Two months ago, they forecast a 4.5 percent drop. The ratio of ratings upgrades to downgrades is the lowest since the first quarter of 2009, which was during the financial crisis. The Bloomberg Bankruptcy Index has been creeping up all year, and stands at its highest level since 2014.
Deutsche Bank AG strategists forecast that risk premiums for the bonds relative to Treasuries could widen by as much as 8 percentage points over the cycle. Meanwhile, UBS Group AG strategists say high yield spreads could narrow by about 0.65 percentage points or 0.75 percentage points in the next three to six months.
Global growth issues have not been cleared up despite the recent junk bond rally, which should give investors pause, said Marvin Loh, senior fixed-income strategist at BNY Mellon Global Markets. "Assets had been rich at the beginning of the year, and have returned to that rich status with the recent bounce."
Junk bonds yields are on average about 7 percentage points higher than Treasury yields now, almost exactly where they started 2016.
"Valuations are not cheap, so you might see us dial down the risk a bit," said AB’s Distenfeld.