Love of Junk Resumes With Biggest Deposit of ’14: Credit Markets

Aug 22, 2014 6:40 am ET

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Aug. 22 (Bloomberg) -- U.S. high-yield bond funds recorded the biggest weekly inflow of 2014 as investors returned to the riskiest corporate debt following an unprecedented withdrawal at the start of August.

Mutual funds and exchange-traded funds that buy junk bonds attracted $2.2 billion in the week ended Aug. 20, according to data provider Lipper. That’s the second straight week of inflows after investors pulled $7.1 billion in the five days ended Aug. 6, extending redemptions to as much as $12.6 billion over a four-week period.

Demand is soaring for the debt as buyers purchase bonds with yields that reached the highest in more than eight months, banking on the Federal Reserve to keep suppressing interest-rate targets it has held near zero since 2008. Money managers including Pacific Investment Management Co. have snapped up higher-rated junk bonds dumped by debt managers amid the recent exodus.

“Every time the market has sold-off over the past couple of years, it’s come back quickly,” Michael Anderson, a New York-based credit analyst at Citigroup Inc., said in a telephone interview. “Investors are being conditioned that they are going to be rewarded if they buy in weakness.”

Yields Drop

Exchange-traded funds that purchase debt rated below investment-grade in the U.S. reported $573 million in inflows in the last week, according to 30 such funds tracked by Bloomberg. The funds, which manage about $36 billion in assets, gained 0.7 percent in the same period.

The effective yield on the bonds has dropped to 5.54 percent after increasing to 6.04 percent on Aug. 1, the most since November, Bank of America Merrill Lynch index data show.

“This is a starting-gun problem,” William Larkin, a money manager who oversees more than $500 million at Cabot Money Management, said in a telephone interview from his office in Salem, Massachusetts. “There’s reason to be worried about high yield but there are those that believe that there is still more returns left in this asset class before the Fed changes policy and you need to flee.”

The extra yield investors demand to own the debt instead of similar-maturity Treasuries has retraced half the amount it increased during the sell-off, narrowing 44 basis points since Aug. 1 to 381 basis points, Bank of America Merrill Lynch index data show. They were as low as 335 basis points on June 23.

Risk Gauge

The risk premium on the Markit CDX North American High Yield Index, a barometer of risk tied to the debt of 100 speculative-grade companies, dropped yesterday to the lowest level in more than a month and is poised for the biggest monthly decline since February.

“Credit risk premium had widened dramatically and that was an entry point for most of the market participants,” said Gary Herbert, a fund manager at Brandywine Global Investment Management LLC, which oversees about $45 billion in fixed-income assets. “We’ve been using the opportunity to add exposure across our high yield accounts. It’s a relatively benign environment in credit and there’s some money to be made.”

The Markit CDX index, a benchmark for the credit-default swaps market, has dropped 47 basis points to 307 basis points after reaching a six-month high of 354 at the start of the month, according to prices compiled by Bloomberg. The index typically falls as investor confidence improves and rises as it deteriorates.

‘Quite Attractive’

Junk bonds in the U.S. have gained 1.32 percent this month, erasing a loss in July of the same amount. That has extended returns for the year to 5.6 percent, the index data show.

In their rush to meet redemptions, high-yield money managers picked the wrong assets to sell and created pricing that’s “quite attractive” for some instruments rated just below investment grade, Mark Kiesel, Pimco’s global head of corporate bond portfolio management, said at a media briefing in Sydney earlier this week.

Investors are also returning to high-yield debt in Europe where the region’s biggest junk bond exchange-traded fund saw the largest daily inflow on Aug. 20 since May, which almost erased the week’s withdrawals. They placed 61.3 million euros in the iShares Euro High Yield Corporate Bond ETF, paring the week’s withdrawals to 4.8 million euros, according to data compiled by Bloomberg.

Market Revival

The debt handed investors 0.5 percent this week in the second consecutive week of returns, Bank of America Merrill Lynch indexes show. Demand for the securities has pushed average yields down 40 basis points to 3.9 percent from a six-month high of 4.3 percent on Aug. 8.

The revival in the high-yield bond market contrasted with continued redemptions in the market for leveraged loans, which have floating rates and are typically rated speculative-grade, or below BBB- by Standard & Poor’s and lower than Baa3 at Moody’s Investors Service.

Investors withdrew $540 million from U.S. funds that buy leveraged loans in the week ended yesterday, increasing net outflows for the year to $3.7 billion, Lipper data show.

The loans have dropped 0.1 percent this month, following a 0.25 percent loss in July, according to the S&P/LSTA Leveraged Loan 100 index.

Increased Rates

At least 15 borrowers last week had to increase the rate on loans they were seeking amid the weakened demand, Bloomberg data show. More deals were forced to boost yields to investors in the five days ended Aug. 15 than any week this year.

Golden State Medical Supply Inc., a generic drugs supplier owned by LKCM Headwater Investments, pulled a $145 million loan that was to refinance debt and fund a shareholder dividend because pricing became less favorable, Bradley Wallace, a partner at LKCM, said in a telephone interview this week.

The cost of leveraged loans sold to institutional investors rose to 4.22 percentage points more than lending benchmarks as of Aug. 14, from 4.03 percentage points in July, according to S&P Capital IQ Leveraged Commentary & Data.

“We’ve had this slow leak of outflows” in the loan market as people have given up on the prospect of long-term Treasury rates rising, Anderson said.

The yield on 10-year Treasuries has fallen to 2.41 percent from 3.03 percent at the start of the year. That still marks a 7 basis-point rebound after dropping to the year’s low amid a flight to the safest asset prompted by heightened geopolitical concern from Ukraine to Gaza.

“There was overarching political risk that worried people,” Brandywine’s Herbert said. “Now there’s a recognition that people can see through some of these conflicts, and we are still expecting moderate economic growth here in the U.S.”

--With assistance from Katie Linsell in Madrid.