A divide is growing in the U.S. corporate debt market.
On the one hand, publicly issued bonds have become more transparent. They are more regulated and more easily accessible to all types of investors through stock-like shares of exchange-traded and mutual funds.
But on the other, an increasing share of corporate debt is moving into the shadows. Privately sold bonds account for a growing proportion of the U.S. credit market, especially among lower-rated companies.
The total amount of North American private debt assets under management surged 35 percent from the end of 2012 through mid-2016, to almost $400 billion, according to Preqin data that tracks private-equity style, closed-end private debt funds. Just as a reference point, the U.S. junk-bond market grew by 26 percent in that period, according to Bank of America Merrill Lynch index data.
This is important, especially now. Investors are plowing billions of dollars into publicly traded credit funds in the wake of the U.S. election in November. While these debt investors are seeking to profit from a benign economy without the risk of stock-like losses, they're entering something that more greatly resembles a gambling parlor because of its susceptibility to sharp moves based on traders' shift in sentiment and strategy as opposed to underlying fundamentals of companies.
Big institutions, meanwhile, are increasingly taking on the lending role that big banks had, except without the same amount of regulatory scrutiny.
The route here is fairly easy to map. The U.S. corporate bond market tracked by indexes swelled in the past decade, largely because of the Federal Reserve's unprecedented effort to suppress bond yields after the 2008 financial crisis. Companies sold trillions of dollars of debt to take advantage of record-low borrowing costs. Investors, seeing few better opportunities, were willing buyers.
But as yields dropped, more sophisticated investors moved a growing amount of their business out of the public market into direct-lending strategies or privately placed debt that offered higher yields in exchange for less liquidity.
This is still happening. The investment advisory arm of Penn Mutual Life Insurance, for example, recently hired Sean McTernan to be director of business development, a new role that will specialize in private debt strategies.
This unit "will be able to market aggressive fixed-income strategies for a private fund managed by an off-the-radar insurer instead of a public venture," according to a Jan. 31 report by Brian Reynolds, chief market strategist at New Albion Partners. "Not only will this product be out of sight of the regulators, but it will also be outside the view of the bearish macro funds that like to short credit products."
It makes sense for Penn Life to do this. And it's certainly not alone; insurance companies have substantially increased their allocations to private debt in recent years. Not only do they expect to earn more, but it takes their investments out of the casino-like atmosphere, where a politician can torpedo an entire market with a Twitter post.
This is an uncertain time, and many traders are turning to the public credit markets to express their jitters by buying or selling funds that track broad indexes of companies. Institutions are looking to opt out of the fray, pinpointing more idiosyncratic opportunities -- such as lending money to one specific company after doing a lot of research and expecting to get repaid along with with some interest.
In the meantime, the credit market continues to become more bifurcated. And the American shadow bank continues to grow.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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