The high-yield bond implosion at Third Avenue created panic. But as the fear subsided, some investors began searching for bargains.
Institutional Investor
December 29, 2015
By Robert Stowe England
The recent rout in the $1.3 trillion U.S. high-yield corporate debt market sent investors running for the exits. The panic began when the $789 million Third Avenue Focused Credit Fund, based in New York, blocked redemptions December 10 and was followed by rising redemptions at other funds with high allocations to energy and commodity bonds. The outlook on high-yield bonds remains negative. “I think the high-yield market will remain under stress as long as commodity prices and energy prices stay this low,” says Jeff Tjornehoj, head of Americas research at Lipper.
The market swoon has investors worried about current holdings and cautious about new allocations. Some investors who have done well in junk bond investing, however, caution against a full retreat. Instead, they suggest that now might be a good time to start thinking about putting money to work in junk bond funds. “We don’t think the Third Avenue liquidity crisis really is the canary in the coal mine for the high-yield corporate-bond market. We worry about excesses, but we don’t think we’re in danger of the broad high-yield bond market collapsing,” says Terri Spath, chief investment officer at Sierra Investment Management in Santa Monica, California.
Sierra, with $2.3 billion in assets under management, has a mandate that allows the firm to buy 100 percent in some of its junk bond funds — or to trim high-yield credit allocations to the bone. “We got sell signals on every potential vehicle that we could put money into for high-yield corporate bonds when there was massive concern about China taking down the whole planet. So we exited there,” says Spath. But today the speculative-grade bond market is starting to look more attractive. “We have not started putting money to work, but I think we’re close,” she says.
More defaults are on the way. There are 187 companies with $222 billion in speculative-grade debt that Standard & Poor’s identifies as the “weakest links,” meaning they are rated B-minus or less, according to Diane Vazza, head of global fixed-income research at the New York–based credit-rating agency. S&P is forecasting that 60 to 87 more U.S. junk bond issues will default by the third quarter of 2016. S&P estimates that $66 billion of oil and gas junk bonds are distressed, that is, they trade at spreads of 1,000 basis points or more over Treasuries. In metals, mining and steel, 72 percent of bonds, some $29 billion worth, are distressed.
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