Lower Quality Will Beat Longer Bets on Junk Debt, BofA Says

  • Favors first-lien loans, bonds rated B in the fourth quarter
  • Money managers may be pressured to catch up on returns

Lower quality will probably do better than long maturities in junk debt for the rest of this year. That’s what Bank of America Corp. strategists led by Michael Contopoulos are telling investors, despite misgivings about the sector’s rising risks.

The prospect of the Federal Reserve raising interest rates in December poses a greater threat than the added possibility of default that comes from a slightly lower rating, according to Contopoulos, BofA’s head of high-yield credit strategy. He’s recommending investors consider first-lien leveraged loans, then corporate bonds rated B.

"The next place to rally in high yield will be the next-riskiest part of the market outside of BBs," Contopoulos said in a phone interview. "We’re very wary to be in long maturity right now," he said. "Your higher-duration products will hurt you if you do have any sort of policy shift."

Contopoulos outlined the dilemma in a report to clients this week, which said the strategists are “uncomfortable with fundamentals” including earnings. “Although we don’t think low rates are going away any time soon, in our opinion valuations and rate sensitivity are overlooked as meaningful concerns,” the analysts wrote.

Debt with B ratings may rally in the fourth quarter due to European and Japanese investors chasing relatively safe yields, and underperforming money managers trying to catch up by taking more risk before the year ends, Contopoulos said.

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