Finance

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

American International Group essentially just made a multibillion-dollar decision to sell low and buy high.

Falling Fortunes
AIG's shares have fallen after two consecutive unprofitable quarters.
Source: Bloomberg

The embattled firm, which has been struggling in the face of souring investments and poor insurance underwriting, recently opted to withdraw from about half the hedge funds in an $11 billion portfolio. Instead, it's planning to use that cash to buy investment-grade debt and make commercial mortgage loans, according to Bloomberg News reporters Sonali Basak and Lily Katz.

AIG is basically withdrawing money from risky assets that have sold off drastically to buy top-rated debt that's relatively expensive. The bet may pay off because the insurer estimates it can free up about $2 billion in additional capital after reducing the risk in its investments.

But it's highly unclear that the firm can invest in any endeavor that could pay off as highly as some distressed opportunities may right now. And it's odd to lock in losses and liquidate positions at a time of mounting uncertainty and distress in riskier markets.

Taking a step back from the hysteria, it seems as if there's much more potential upside in some highly distressed, nonenergy high-yield bonds right now than there has been in years. Impossibly low junk-debt yields have given way to a hefty 10.2 percent on average among dollar-denominated notes, almost double what they've been in the recent past. Yields on investment-grade notes are still just 3.6 percent, about one percentage point from their all-time low.

Split Paths
U.S. junk-bond yields have surged as investment-grade yields have remained relatively constant.
Source: Bank of America Merrill Lynch index data

Sure, prices on top-rated bonds may keep rising as global growth continues to muddle along or even deteriorate further. And prices on riskier debt will probably keep falling for a bit longer, especially as more investors do exactly what AIG appears to be doing, heading for the exits.

And granted, not all hedge funds are successful at making risky bets, to make an understatement. Many have struggled (and closed) in the wake of the recent market turmoil. AIG is withdrawing money from 50 of the 100 funds it allocates to after reporting $220 million of hedge fund-related losses in the fourth quarter and $324 million in the third.

But to pull out now -- after junk-bond prices have plunged to 83.7 cents on the dollar from 101.3 cents about a year ago and after stocks globally have declined 15.7 percent in the period -- seems like an impulsive decision. Why didn't AIG do this two years ago, when it seemed pretty obvious to many that prices were way too high on riskier securities? 

And to plow that money into debt that's perceived as safe is also a potentially problematic, unhedged wager. There are signs that the investor appetite for investment-grade corporate debt is starting to cool a bit, for example, especially as investors prepare for a growing number of companies to be downgraded to junk.

If you strip out any gains tied to benchmark Treasury yields, investment-grade corporate bonds in the U.S. have actually lost 3.3 percent so far this year, according to Bank of America Merrill Lynch index data.

AIG has some decent reasons to shift its allocation around. But it feels a bit like they're making a classic rookie investment mistake of just following the herd and making a knee-jerk response rather than a thought-out investment decision.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net