The Fall of a High-Yield Fund Echoes 2007 Crunch
The high-yield corporate bond market, where junk-rated companies go to borrow money, has been in trouble recently. This sector of the fixed-income market suffered its worst quarter in four years in the three months to September. And, at the risk of getting all Chicken Little, one of the consequences is reminiscent of the start of the credit crunch.
Here's a chart showing what's happened to returns from high-yield debt so far this year. Note that the rebound since the nadir for both dollar and euro investments still leaves investors languishing where they were in February, and far below the halcyon days around mid-year:
That slump has claimed a high-profile victim. The Managed High Yield Plus Fund was introduced to the market by Swiss bank UBS in 1998. It survived the dot-com bust at the start of 2000, the slump in telecom company values soon after, and even the 2008 collapse of Lehman Brothers that was the biggest bankruptcy in U.S. history. Earlier this month, though, UBS said it plans to close the fund:
After a thorough review of the available alternatives, and based upon the recommendation of UBS Global Asset Management (Americas) Inc. ('UBS AM'), the Fund’s manager, the Board has determined that liquidation and dissolution of the Fund is in the best interests of the Fund.
High Yield Plus had been trading at a deeper and deeper discount to its net asset value; as this chart shows, it's worth more dead than alive:
It's not just the dollar and euro markets that are in a tailspin. Geof Marshall, a portfolio manager at CI Investments, said last month that his market is "on life support." He told the Bloomberg LIVE Canadian Fixed Income Conference in New York that "we need to get investors to come to this market. We need to get issuers to come to this market."
A number of issues plague the high-yield market. Oil prices languishing below $50 a barrel and commodity prices still weak across the board are bad news for miners and energy companies. Moody's reckons European mining companies alone have to repay $9 billion of junk debt this year. The International Monetary Fund warned earlier this month that there's a heightened risk of a monetary-policy misstep damaging the global economy; slower growth means less corporate profit to service debt. And the rout that's seen more than 30 percent wiped off the value of Chinese stocks since they peaked in July is evidence that debt-laden emerging markets -- where many high-yield borrowers are based -- are particularly vulnerable to a faltering recovery in world growth.
But why worry about the disappearance of a single investment fund, albeit one with a venerable history? History rhymes, even if it doesn't repeat, and there's a particular slice of the past that no one wants to see echoed.
On the morning of Aug. 9, 2007, the French bank BNP Paribas announced it was freezing redemptions from three investment funds it controlled. Because it couldn't put a reliable value on the assets the funds owned, it told investors they couldn't have their money back. Later that morning, the credit markets froze as banks refused to lend to each other; the cost of borrowing dollars overnight, for example, spiked to 5.86 percent from 5.35 percent. It signalled the beginning of the credit crunch..
I'm not saying the closure of the UBS fund portends the start of a second financial Armageddon. But at a time when central banks are trying to get trillions of dollars into the real economy so that companies can invest and hire, the malaise in high-yield debt is cause for concern; at this delicate stage in the global recovery, corporate funding might be getting tighter, not looser.
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