The boldest debt investors hit a few home runs this year.
I highlighted some of the most unpopular bets earlier in the year, and three out of four of them worked out pretty well. Russian sovereign debt, a complete pariah investment in 2014, has produced a 32 percent gain so far this year, while Greek government debt produced a return of more than 20 percent. High-yield debt of Chinese companies, which also seemed sketchy in January, delivered a 9.8 percent gain, according to Bank of America Merrill Lynch index data.
If an investor had put a billion dollars into each of these strategies, they could’ve theoretically earned an estimated $630 million profit. Not too shabby.
There was, of course, one big exception: oil-related debt. While investors were already souring on such notes by the end of 2014, at this point they might as well use junk-rated energy bonds as dart boards. Some of the notes aren’t worth the paper their prospectuses are printed on.
As a whole, the lowest-rated energy bonds have lost 25 percent in 2015. A billion dollars invested in this world of hurt would’ve left investors about $250 million poorer.
Looking ahead to next year, there are a few new nausea-inducing wagers that investors can make that could end either in riches or tears. Here’s a look at a few.
1. Head down to Brazil. This nation is poised for its longest recession since the 1930s in the face of a corruption scandal and tumbling commodity prices. Brazilian government bonds maturing in 10 years are now trading at 80.4 cents on the dollar, down from more than 100 cents on the dollar in January. The currency is down more than 30 percent against the dollar this year.
While the country, Latin America’s biggest economy, could experience an even more severe downturn, its securities may recover a great deal of value if oil prices stabilize and new leadership fosters a sense of political stability.
2. Take another stab at oil companies. This has been one of the year’s most painful bets, with crude prices falling lower, lower, and then lower some more, punching some huge holes in the balance sheets of highly leveraged drillers and pipelines. Fund managers who dove into U.S. junk-rated bonds of energy companies earlier this year were fiercely punished. Yields on the notes are now an average 16 percent, the highest since 2008. A handful of these companies have already filed for bankruptcy, and more are likely headed down the same path.
If oil prices recover a bit, these bonds may produce a windfall. But that’s a big if. Oil production is still high. And China, the biggest consumer of energy, is meaningfully slowing down.
Let’s say prices stay low or drop even more for most of 2016, which is not out of the question. Some of these companies will still survive. If a fund manager has enough time and cash to keep the best of the energy producers alive through the turmoil as their peers die out, they’ll likely be better positioned to survive and thrive in the years after.
3. In a related industry, some metals and mining companies may hold promise. Dollar-denominated debt of such corporations has plunged almost 14 percent this year, with yields rising to 7 percent. That may not be nearly enough to compensate some bond buyers for the losses they’re about to experience. The default rate is rising quickly, and it’s hard to see what will keep many of these borrowers from going out of business.
However, the biggest companies are trying to curtail their debt and focus on their strongest lines of business. Some debt of Glencore and Freeport-McMoRan, for example, may rebound a bit, especially if iron ore and copper prices recover at all.
4. Business development companies, which receive tax benefits to lend to small and midsize businesses, have been hammered for several years in a row. Investors just haven’t been able to sell their stakes in them quickly enough. Prices on such companies have plunged 13 percent this year on average after an abysmal performance in 2014 as well.
At the same time, some of the companies generated returns that were greater than 10 percent based on the fact that the loans they held continued performing, with borrowers making regular interest and principal payments. Investors could win by picking the right BDC shares to buy and holding them for a prolonged period.
Perhaps the failed energy, metals and mining bets of 2015 will be enough to prevent investors from taking big risks next year. Individual investors have been withdrawing their money from mutual funds that invest in junk-rated securities, further dampening risk appetite on a broader scale. But some investors will be brave, and some will inevitably be richly compensated for their efforts.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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Lisa Abramowicz in New York at firstname.lastname@example.org
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