Junk-bond sell-off just a blip, managers say

Although the high-yield market might not have changed fundamentally, junk-bond yields have taken a noticeable dive from their peak late last month

Feb 10, 2013 @ 12:01 am

By Jeff Benjamin

The recent bumpy stretch for high-yield bonds attracted some market attention and reminded investors of junk bonds' correlation to equities.

But as the dust settles, the consensus is that the bond volatility, at least this time around, probably didn't warn of a looming stock market correction.

“Nothing has changed in the high-yield market over the past few weeks,” said Jim Sarni, managing principal at Payden & Rygel Investment Management, which handles $83 billion in fixed-income portfolios. “This is just a little bit of a reaction to some of the buyouts that are happening right now.”

Although the high-yield market might not have changed fundamentally, junk-bond yields have taken a noticeable dive from their peak late last month, which looks a lot like a sudden market sell-off.

The high-yield exchange-traded fund iShares iBoxx High Yield Corporate Bond (HYG) is up about 34 basis points for the year but down 1.3% since Jan. 22.

Likewise, the SPDR Barclays High Yield Bond ETF (JNK) is essentially flat from Jan. 1 but off 1.5% from a Jan. 28 peak.

“I think this is just noise,” Mr. Sarni said. “I would be willing to bet that by the end of the month, we will see another positive month for high-income bonds.”

He is downplaying the recent volatility as a byproduct of bond investors' freeing up cash to take advantage of new issuance, including debt that will come from the $24.4 billion leveraged buyout of Dell Inc.

“The Dell deal has definitely created some expectation of significant new supply of debt, and it has some people building a little cash to be in a position to absorb that,” said Edward Meigs, manager of the First Eagle High Yield Fund (FEHIX).

"A LITTLE ASLEEP'

He hasn't seen a change in fundamentals in the high-yield-bond market, he said, but the category “sort of seemed like it was a little asleep” when the yield on the 10-year Treasury bond climbed briefly above 2% two weeks ago.

Even though they are debt instruments, high-yield bonds are often more correlated to equities than to Treasuries. But such market realities can be difficult to accept when interest rates are at historic lows and showing signs of inching higher.

“People got a little shaky when they saw the 10-year Treasury move above 2%,” said Fran Rodilosso, portfolio manager of Van Eck Global's Market Vectors ETFs.

“High yield typically tends to be less sensitive than investment-grade bonds when rates move, but right now, everything is so compressed,” he said. “If we do start to see real flows move out of high yield right now, it's probably not a risk-off trade to go into money market funds; it's more likely a move to take some [profit] off the table.”

While rising rates should alert holders of investment-grade debt, investors in high-yield debt generally follow a different set of market signals.

“High-yield bonds are affected by interest rates, but they also tend to be highly correlated to the equity market,” said Brian Gendreau, a market strategist at Cetera Financial Group Inc. and professor of finance at the University of Florida.

Even though yield spreads between the highest- and lowest-quality bonds have narrowed, high-yield bonds still enjoy a buffer that should protect them from sudden rate movements.

However, bonds become more ex- posed to credit-related volatility as the debt quality moves further from investment-grade toward distressed. That is where high-yield bonds start to act like stocks and why a jolt in the high-yield market can make equity investors nervous.

“What makes high-yield bonds high-yielding is that they're usually issued by companies with a lot of leverage,” Mr. Gendreau said. “So if a company goes under, you, as a bondholder, end up with a claim on the company's assets, which effectively makes you an equity holder.”

NEGATIVELY CORRELATED

Although the most-liquid and highest-quality bonds will be most sensitive to rates, junk bonds can even be negatively correlated, Mr. Sarni said.

“When rates are rising, generally speaking, the level of economic activity is picking up, and that's good for high-yield bonds because these are companies that will maybe have less cash,” he said.

Another way to look at it would be to consider high-yield debt as a hybrid that can cut both ways, according to Mr. Gendreau.

“Wall Street thinking has usually been that bond investors are smarter than equity investors, but a dip for high yield can be concurrent but probably not a leading indicator for stocks,” he said. “Basically, buyers of high-yield bonds have two reasons to think the stock market run will not last, while equity investors only have one reason.”

jbenjamin@investmentnews.com Twitter: @jeff_benjamin

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