Junk Yields Pay for ‘Difficult’ Liquidity, T. Rowe’s Gitlin Says
Speculative-grade bonds are more attractive than investment-grade debt as higher yields compensate for “difficult” liquidity, according to Mike Gitlin, T. Rowe Price Group Inc.’s director of fixed income.
“On the high-yield side, we’re willing to take less liquidity because our all-in yields are closer to 9 percent, whereas all-in yields on investment-grade corporate bonds are less than 4 percent,” Gitlin said today in an interview following a press briefing at the Princeton Club in New York.
While corporate balance sheets are rich with cash and companies are holding historically low levels of debt, secondary bond trading is “very, very difficult right now,” Gitlin said at the briefing. “We don’t like the liquidity but we like the fundamentals.” Liquidity is a measure of the ease of buying and selling securities.
Broker-dealers, the biggest providers of daily liquidity, are shrinking corporate bond inventories as pending regulatory changes impose trading restrictions and increase the cost of holding such securities, Barclays Capital strategists led by Jeffrey Meli wrote in a Nov. 18 report. Half of the high-yield trading volume in the first three quarters of 2011 was concentrated in 46 out of 1,140 tickers, the strategists wrote. In the firm’s U.S. Corporate Index, the 37 most liquid credits of nearly 628 accounted for half of the volume.
T. Rowe Price, the Baltimore-based money manager that oversees more than $453 billion of assets as of Sept. 30, is overweight high-yield corporate bonds, emerging-market debt in dollars and local currencies, and mortgages, relative to benchmarks in multisector portfolios, Gitlin said after the briefing. The company is neutral on investment-grade corporate bonds and underweight on Treasuries.
Brian Rogers, chief investment officer of the firm, said at the briefing that “in 2011, the new asset of irrational exuberance really is the 10-year U.S. Treasury.”
High-yield bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, rallied 5.96 percent in October after the worst two-month performance since the last quarter of 2008, while investment-grade debt gained 1.75 percent the same month, according to Bank of America Merrill Lynch index data. Junk bonds yield 9 percent as of yesterday compared with 3.9 percent on investment-grade debt.
“That’s a big concern of ours that secondary-market liquidity will remain poor for the foreseeable future,” Gitlin said today. “That’s a significant concern.”
New industries may emerge to boost trading in corporate bonds if liquidity remains at current levels, he said.
“If it ends up being the landscape for too long, lots of different cottage industries come up from the ground when you have a need for a different type of liquidity,” he said. “Whether it’s investors facing off against one another in a more electronic manner, that may be a cottage industry that comes up in the fixed-income world if liquidity provided by the large broker-dealers continues to evaporate.”
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