Junk Bond Recovery Seen After Biggest Quarterly Slump Since 2011

High-yield bond investors, smarting from the biggest quarterly losses since 2011, are forecasting a turnaround by the end of the year as depressed prices and low default rates lure back buyers.

Speculative-grade notes worldwide forfeited 1.7 percent in the last three months, the worst performance since the third quarter of 2011, according to Bank of America Merrill Lynch index data. The average yield on the debt climbed to a one-year high of 6.26 percent on Sept. 29, the data show.

“The weak quarter has provided investors with arguably the best entry point for the global high yield asset class we’ve seen this year,” said Peter Higgins, a London-based senior high-yield portfolio manager at BlueBay Asset Management Ltd., which oversees about $55 billion. “The fourth quarter will be positive because the asset class provides good value to recover from losses.”

Investors shied away from riskier securities as tensions from eastern Europe to Hong Kong roiled markets and on speculation U.S. economic expansion will bring forward interest-rate increases. Price declines triggered by the selloff are now creating buying opportunities as default rates fall to historic lows.

The trailing 12-month global default rate for junk-rated corporate debt will decline to 2 percent at the end of this year, the lowest since at least 2011, Moody’s Investors Service forecast on July 10.

‘Fair Value’

“Defaults should remain low and there may be some spread tightening from here,” said Stefan Isaacs, a fund manager at M&G Investments in London which oversees more than $434 billion of assets. “The market is much closer to fair value now.”

The bonds of state-controlled oil company Petroleos de Venezuela SA and U.S. casino operator Caesars Entertainment Corp. were the worst performers in the last three months, losing 15.9 percent and 14.4 percent respectively, Bank of America Merrill Lynch index data show.

Companies worldwide issued $114 billion of high-yield bonds in the period, pushing issuance this year to an all-time high of $445 billion, according to data compiled by Bloomberg. That compares with the previous record of $371 billion for the first nine months of 2013.

Junk bonds will deliver total returns of 1.5 percent to 2 percent in the final quarter, according to M&G’s Isaacs. The securities could hand investors as much as 3 percent during the period, said Andrew Lake, the head of high yield at Mirabaud Asset Management Ltd. in London.

“When the economy improves like we’re seeing in the U.S., credit should do well because balance sheets get better,” said Lake, who helps manage $8 billion of assets. “High yield should bounce back in the fourth quarter.”

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