Junk bond investors burnt in Fed retreat

June 24, 2013 5:25 pm

Junk bond investors burnt in Fed retreat

By Michael Stothard, Vivianne Rodrigues and Josh Noble

Those who followed the “close your eyes and buy” strategy that swept through junk bond markets since the start of the year have just had their fingers burnt.

The hardest hit casualties of a rout in high yielding debt over the past few weeks have been the more esoteric or lowly rated instruments, the very credits into which investors had been pouring money due to the slight pick-up in yield on offer.As some had warned, these were the first assets to tumble in value when the US Federal Reserve hardened its language on when it would start to start reducing its $85bn a month of bond purchases.

The biggest fallers in junk include debt issued byChesapeake Energy and Quicksilver Resources in the US, while in Europe Avanza and Eircom have been hit hard. New World Resources has seen its bonds fall 30 per cent.

Overall, high yield bonds have fared better than the investment grade market because – by definition – their higher coupons offer a larger cushion against potential losses driven by a back-up in US Treasury yields.

Returns on global investment-grade corporate bond have been minus 2.6 per cent this year due to sharp losses over the past month, for example. But high yield returns are still just positive, according to Barclays indices.

But that does not tell the whole story because the lowest-rated credits in the junk bond market have taken a beating.

The JPMorgan CCC index, a basket of some of the riskiest credits, has seen yields – which move inversely to prices – rise by more than a third from 8 per cent last month to nearly 10 per cent.

This is because the rise in US Treasury yields has removed incentives for investors to buy the very riskiest parts of the corporate debt market to earn the extra yield. This was powerful force that has pushed junk bonds higher in recent years.

Alberto Gallo, a credit analyst at RBS, says that even though average credit spreads on junk bonds have widened they are still not a high as at the start of the year. It is mostly that the “end of the ‘mine-everything’ trade is rocking markets”.

Michael Moravec, co-head of European leveraged finance origination at Barclays, says: “It has been some of the slightly more ambitious transactions that widened most notably post pricing.”

Greek debut hit

It was never going to be the easiest of bond issues to get away, but Intralot, a Greek company that makes software and hardware for the gaming industry, was forced to postpone its proposed €300m debut bond issue last week.

This was only the third deal to be delayed in Europe this year, and it is indicative of the severe market turbulence that has struck the more speculative end of the junk bond market. The other European deals pulled have been TVN in March and Unilabs earlier this month.

The sharp weakness in lowly rated credits has also hampered the high-yield new issue market in recent weeks, a key source of financing for smaller or highly leveraged companies.

Last week was the slowest week for global junk bond issuance since the start of January, according to Dealogic, with just $3.7bn worth of issuance in 14 deals.

High yield’s fall from grace has been clearly visible in Asia. There, the boom in junk bonds made 2013 a record year by April, with $22bn raised – well in excess of last year’s total of $16bn – according to Dealogic. But not a single high yield bond deal has printed in more than a month. Indian energy company Vedanta was the last company to raise cash in the market on May 22, the day Ben Bernanke, Fed chairman, started to discuss “tapering”.

“A lot of major investors have been quite conservative in their positions for quite a while now,” says one Asian debt banker. “They have cash, they have taken profit as well. What they are doing now is watching the market and waiting for a better entry point.”

Traders are saying the few companies now venturing into the US debt market – mostly super-safe utilities trying raise funds before borrowing costs get even more expensive – are having to accept concessions to drive deals through.

The big concern now for those still holding on to their junk bond portfolios is that bond prices have further to fall. In spite of last week’s sharp sell-off, some prices may still not be low enough to attract a new wave of buyers, say investors.

“I’m still not convinced the full impact on bond markets from [the Fed’s] tapering remarks has been fully played through last week,” says Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock. “We may not be there yet in terms of a rebound.”

Investors pulled €927m out of European high yield funds this month, according to JPMorgan data, while the much larger US high yield market has seen $9.1bn in outflows over four weeks, according to Lipper data.

Ray Nolte co-managing partner and chief investment officer of SkyBridge Capital, agrees that demand is unlikely to pick up: ““Early next year it would not surprise me if US yields were approaching 3 per cent,” he says. “Unless you fall back into recession, I just don’t see appetite for investors to keep waving in fixed income.”