Fear and loaning: Investors are running from junk bonds

Dollar bonds of sub-investment grade Indian firms have seen yields rise in recent weeks in response to a sharp sell-off in the global junk bond markets, which is making investors nervous.

While the bid-offer yield quoted for bonds of Tata Steel, Reliance Communications and DIAL are at least 40 bps lower than the level at which they were issued, the yield on bonds of commodity-centric exporters such as Vedanta and JSW Steel have more than doubled, the banker added. Because they’re riskier, they typically pay higher returns.

Just as turkeys are opposed to Christmas on culinary grounds, so investors in risky assets like junk bonds are forever and always against interest rate hikes. Battle said. “And the high yield market has been selling off for awhile”.

In addition to seeing their yields soaring above US Treasuries of a similar maturity (as the graph above illustrates) high yields bonds are set for their worst performance since 2008. One is about liquidity, which was never ample in the high-yield market, a fact that investors in supposedly liquid instruments like exchange traded funds tended to elide over.

Companies commonly use the proceeds from bond issues to fund buybacks or dividends, flattering earnings and potentially increasing their stock price but doing nothing to make a company a better longer-term bet.

This relationship between junk and stocks is why we need to watch the high-yield markets carefully. “So there’s no major exposure for the financial sector”, he said. That’s about average, Fridson says, suggesting that concerns about defaults outside of the energy sector aren’t running any higher than normally.

Fundamentals, in the form of the oil price, have been poor for most of the a year ago, but OPEC’s decision in early December to extend its price war on shale producers rammed crude prices down another 10%.

Monday’s bloodletting, the latest in a rout that began last week, saw units of SPDR Barclays High Yield Bond ETF, slide US$0.27 to US$33.42 on Monday, their lowest close since March 2009.

The hedge fund Stone Lion Capital Partners also said it was barring redemptions from one of its funds.

In July 2014, the company had $3.5 billion in assets.

A major junk bond mutual fund shut down last week. “This fund was very concentrated in low-quality, even distressed, names, ” she said of Third Avenue Focused Credit. What’s more, around 20% of the assets of the Third Avenue fund were in bonds that didn’t actively trade. Having a non-investment grade rating means that mainstream unit trusts (like South African balanced funds) and pension funds are precluded from investing in them. It’s what Federal Reserve Governor Jerome Powell warned in February was a “liquidity illusion” that can quickly evaporate amid market shocks.

Fridson said he wasn’t as anxious about liquidity.

With so much uncertainty in the market, Lucidus Capital Partners, a high-yield hedge fund, said Monday that it has liquidated its entire portfolio and will return the $900 million it has under management to investors next month.

Investors are scared. Junk bond demand is one of seven indicators in CNNMoney’s Fear & Greed Index. Much of the money from both high-yield and the corporate bond market generally has gone, not to productive investment, but to financial engineering.

Morgan Stanley also wrote in their noted that there are far fewer derivatives tied to high-yield debt than there were to mortgages, which should limit losses if things truly go south. “We believe it is important to note that the systemic implications of the current environment are significantly more muted than in 2007/2008”, wrote Morgan Stanley’s credit analysts in their note.