Oaktree’s Howard Marks Echoes Icahn Warning on Junk-Debt ETF

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Investors who have sought the convenience of exchange-traded funds to buy junk-rated loans and bonds would do well to show restraint, according to the head of the world’s largest distressed-debt investor.

“These are not markets where there is a constant two-way flow,” Howard Marks, founder and chairman of Oaktree Capital Group LLC., said in a telephone interview. “People will tell you that ETFs should work just fine. And maybe they will.  But I have seen many times over the years that things that should happen don’t always happen.”

Billionaire investor Carl Icahn criticized firms such as BlackRock Inc. this month for selling ETFs that purchase “extremely illiquid” securities. The U.S. junk-debt ETF market has grown to more than $43 billion as the product has attracted everyone from individual investors to institutions looking for an easy way to access high-yielding securities.

“In recent periods of market stress, ETFs have added liquidity beyond what’s available in the underlying bond market,” Melissa Garville, a spokeswoman for BlackRock, said in an e-mail. “They have been tested and performed. That’s why, rather than part of the problem, they are part of the solution to the liquidity challenges in today’s bond markets.”

Leveraged-loans trades can be especially lengthy, taking almost three weeks to complete. ETFs for the asset class, which were nonexistent four years ago, have grown to almost $7 billion as funds attract investors with the promise of protection from rising interest rates.

Poor Logic

“It’s not very good logic to say interest rates are going to rise, so buy a floating-rate loan ETF,” Marks said. “How is the ETF going to perform relative to the underlying loans? That’s the part we don’t know. I’m not indicting the idea; I’m just raising the question.”

Trading volumes of the five-largest credit ETFs have grown 75-fold, according to a study from Greenwich Associates released in May. The report, which included interviews with institutional investors, found that many of these firms plan to increase their use of ETFs.

“The positives of most financial innovations are trumpeted,” Marks said. “And the buyer usually isn’t in position to detect or evaluate the negatives.”

BlackRock Inc.’s $14 billion iShares iBoxx High Yield Corporate Bond ETF, the largest junk-bond ETF, is trading at its lowest level of the year amid a commodities rout that is impinging on the ability of companies in the industry to pay their debts. Invesco Ltd.’s PowerShares Senior Loan Portfolio fell to similar lows as the market for below investment-grade debt hands losses to investors this month.

“It doesn’t make much sense for an investment vehicle to offer more liquidity than the underlying assets, and most of these vehicles haven’t been tested in tough times,” Marks said. “Nothing is learned in the investment world in good times.”

(Updates with BlackRock comment starting in fourth paragraph.)
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