Junk Bonds Lure $680 Million as Demand Reappears: Credit Markets

For the first time in more than a month, investors are putting more money into junk-bond funds than they’re withdrawing as the market recovers from its biggest slump in a year.

Investors deposited $680 million into U.S. high-yield bond funds in the week ended Aug. 13, following a record $7.1 billion withdrawal the prior period, according to Lipper. From July 10 to Aug. 6, they pulled $12.6 billion.

Demand is emerging after the more than $1 trillion market lost 1.92 percent in value from June 23 to Aug. 1 as geopolitical conflicts escalated in Ukraine and Gaza, prompting investors to dump risky assets. Since then, the debt has gained 1.38 percent, with firms from Citigroup Inc. to Barclays Plc recommending investors snap up the securities.

“When we saw these big outflows we were looking to buy stuff,” said Mark Okada, chief investment officer of Dallas-based Highland Capital Management LP, which manages $19.5 billion. “You would think the massive outflow would have done more damage to prices, but the market has been handling it pretty well.”

The extra yield, or spread, investors demand to own the debt instead of Treasuries has narrowed to 3.97 percentage point from 4.25 percentage point on Aug. 1, according to Bank of America Merrill Lynch index data. Yields have fallen to 6.01 percent from 6.3 percent on Aug. 1.

Switching Opinions

“Once we got to 6 percent yields, a lot of people switched their opinions from being overvalued to being a bit undervalued,” said John McClain, a credit analyst at Diamond Hill Capital Management Inc. in Columbus, Ohio. “There’s still value in the asset class and we’re seeing people nibble where they can.”

While sentiment improved toward junk bonds, investors continued their retreat from leveraged loans. They pulled $687 million from U.S. funds that buy the debt, bringing net outflows to $3.2 billion this year, according to Lipper. Last week, investors withdrew $1.5 billion, the most since August 2011.

The sell-off came because investors grew concerned that yields on junk-rated loans and bonds had narrowed too much, according to Richard Farley, a partner in Paul Hastings LLP’s leveraged finance group in New York. Federal Reserve Chair Janet Yellen has said the markets showed signs of froth.

Sweetening Terms

Speculative-grade companies have struggled to borrow as buyers fled. Leveraged-loan issuance of $9.7 billion and junk-bond sales of $2.9 billion this month are both the least for the period since 2011, according to data compiled by Bloomberg.

Issuers from Travelport Ltd. to Acosta Sales & Marketing are among at least 20 borrowers this month that increased interest rates on loans they were seeking to attract buyers, Bloomberg data show.

Bioplan is postponing until September $520 million of loans for its merger with Arcade Marketing because of the weak market, according to a person familiar with the matter, who asked not to be identified citing lack of authorization to speak publicly.

“There’s a little bit more of a swing toward an investor-friendly environment,” Farley said in a telephone interview. “The appetite to push the envelope on terms is nil right about now.”

Loans have lost 0.6 percent since the end of June, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index. Prices of the debt have declined each week since July 6, averaging 97.87 cents on the dollar yesterday, the index data show.

Bank of America Corp. analysts predict junk-bond yield spreads will tighten by year-end as the Fed’s easy-money policies support demand for the debt.

Defaults Fall

The U.S. speculative-grade default rate fell to 1.5 percent in June from 2.2 percent at year-end, according to Standard & Poor’s. The credit rater predicts it will climb to 2.7 percent by June of next year, less than two-thirds its long-term average of 4.4 percent.

“Even the potential for retail outflows given further geopolitical instability or the potential increase in rates will be overwhelmed by strong fundamental data, low defaults, and an institutional buyer base that is not easily scared away,” Bank of America analysts led by Michael Contopoulos wrote in a report dated Aug. 13. “We continue to maintain our belief that accounts should be adding risk upon any weakness in names they like.”

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