Junk-Rated Borrowers Reap Rewards in a World of Negative YieldsBy
Investors are loading up on junk as they seek shelter from negative yields.
Buyers put in orders of $4.5 billion for a $375 million bond sold this week by Valvoline Inc., allowing the oil-change store operator to lower the yield on the offering by as much as 0.5 percentage point. That locked in the lowest rate for a junk-rated borrower in more than a month. Mutual funds that buy speculative-grade notes received $4.35 billion of deposits this week, the biggest inflow in more than four months.
For investors with $12 trillion of negative-rate bonds worldwide, U.S. junk securities and their 6.9 percent average yield look like a gold mine. But with so many investors streaming into the market, the debt is now yielding almost 3 percentage points less than the average of the past two decades, Bank of America Merrill Lynch index data show. And they’re buying it up at the same time that junk-rated borrowers default at the fastest pace in six years.
“They’re out there scrounging through the dumpster looking for yield,” said Karyn Cavanaugh, a strategist at Voya Investment Management, which oversees $203 billion. “When you have artificially low rates, you force people to go out and look for things that they normally wouldn’t.”
Oaktree Capital Group LLC’s Howard Marks and BlackRock Inc.’s Laurence D. Fink are warning that investors may be ignoring risks that are arising due to sluggish economic growth and from Britain’s departure from the European Union.
The deposit into junk-bond funds was the biggest since an inflow of $4.97 billion in the week ended March 2, according to data provider Lipper. Investors have also added $2.93 billion to investment-grade accounts and opted to pour more than they took out of leveraged loan funds for the first time in more than a month.
“This isn’t really a normal environment,” Cavanaugh said.
The new appetite for risk comes at the expense of U.S. Treasuries, a traditional safe-haven asset. Yields on the debt have climbed from multi-year lows hit after the U.K.’s June 23 vote to leave the European Union. The 10-year Treasury yield, a benchmark for everything from mortgage bonds to corporate debt, climbed to 1.59 percent at 2:01 p.m. in New York, Bloomberg data show. That’s up from 1.36 percent a week ago.
Some investors expect returns will keep rising in the broader corporate bond market.
Kent White, a money manager and director of investment-grade research at Thrivent Financial, which manages $105 billion, expects the extra yield investors demand to hold top-rated corporate debt over government assets to decline another 0.1 to 0.2 percentage points by the end of the year. The spread dropped Thursday to 1.49 percentage points, a year-to-date low, Bloomberg data show.
“It’s a totally different market,” White said. “There’s a lot of money out there chasing investment-grade credit right now, even given where yields are.”
Investors have shown a willingness to buy new blue-chip company debt even as issuers such as Molson Coors Brewing Co. and Walt Disney Co. have locked in record-low coupons on their recently issued bonds.
Holding these bonds has so far paid -- notes issued by investment-grade companies in the U.S. have returned 8.78 percent year-to-date, according to data compiled by Bloomberg. U.S. high-yield notes have seen gains that top 12.4 percent, among the best performance of any asset class.
Although corporate credit has been “the sweet spot” so far, continued outperformance may be harder to come by in the second half of this year, Barclays Plc strategists led by Bradley Rogoff and Shobhit Gupta wrote in a note to clients on Friday. They expect Treasury yields and spreads to swing with political and economic uncertainty, plateauing returns.
Ray Kennedy, a high-yield money manager at Hotchkis & Wiley, which oversees $28 billion, said he’s watched new money flow into junk bonds but hasn’t seen an uptick in “stupid stuff” -- companies tapping the market to fund shareholder rewards or leveraged buyouts.
“We’ve been pretty disciplined on the new issue side,” Kennedy said.
In the meantime, companies are getting ready to issue debt. Teva Pharmaceutical Industries Ltd. may sell $22 billion of bonds as soon as next week in what would be the year’s second-largest sale of corporate notes. Revlon Inc. plans to offer $400 million of junk bonds to finance its takeover of Elizabeth Arden Inc.
“Even though yields are going lower in the U.S., they’re relatively high in the global context,” said Jason Shoup, a portfolio manager and fixed-income strategist at Legal & General Investment Management America, which manages $121 billion. “There really isn’t another sort of higher-yielding alternative out there.”