Friday, December 18, 2015

OPPORTUNITY HERE?

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This article from Barron's falls into the silver-lining category concerning the recent turmoil in high-yield bonds. Interest rates may have just gone up, but capturing yield is still an important part of the investing scenario.

High-yield fears grow as default wave spreads,” screamed the Financial Times. 


“Typically you get this kind of stuff when you’re close to the bottom,” he observed about the high-profile events hitting the market, notably the shutting of the Third Avenue Focused Credit Fund. That spooked investors even though that fund delved into much more speculative credit than the typical junk fund.
The bright side of the junk storm is that it has restored some measure of value to the market. Kaufman says he’s buying intermediate-term bonds of a company he likes, which originally were issued with yields in the 5%, but now yield in the 8% range as a result of a price drop of about 15%. (He’s mum on the name but says it’s in the tech sector, and nowhere near the oil patch.)

Spreads to be sure are important.

Spreads — the extra yield paid on lower-grade securities to compensate for their higher risk — have increased markedly. The Bank of America Merrill Lynch high-yield index is 709 basis points above comparable Treasuries, up sharply from this year’s tightest level of 438 basis points in early March and 335 basis points at the cyclical trough in June 2014. (A basis point is 1/100 percentage point.)

That’s not extreme undervaluation, given the expected rise in defaults, he says. Starting with a yield of 8.14%, and deducting forecast credit losses of 4.71% (defaults after taking into account recoveries of principal), leaving an expected return of 3.43% over the next five years. To be sure, those defaults are likely to be concentrated in those trouble spots of energy and other commodities.Deft managers have been avoiding those sectors. 

In fact, the trouble spots actually could be still be situated in officially investment-grade companies, according to Cliff Noreen, president of Babson Capital Management, with $223 billion under management, including $40 billion in global high yield. Those sore spots include Glencore and Freeport-McMoRan ( FCX ), which already are trading as junk even though the ratings agencies haven’t confirmed that. 

At a 700-basis-point spread, Noreen thinks investors are being compensated for the risks, which he says are more technical than fundamental. That’s especially the case for high-yield closed-end funds, which he says afford investors the opportunity to buy into an out-of-favor asset class at 10%-20% below their market values. To be sure, part of those discounts reflect the market’s haircut because of the funds’ leverage, which could hurt as the Fed raises short-term rates.

barrons.com/articles/oversold-junk-bonds-pay-10-and-offer-growth 


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