BlackRock Inc., the world's biggest money manager, has been buying junk bonds since relative yields widened to levels that signal default rates more than three times the current pace and in excess of Wall Street's most bearish outlooks for the economy.
“The high-yield market is a great long-term investment at this point and these spread levels,” said James Keenan, head of BlackRock's $28 billion leveraged-finance unit. “In July, we were much more defensive, and we had sold out and built a significant cash position.”
The extra yield that investors demand to hold speculative-grade or junk-rated debt jumped 2.07 percentage points to 7.61 percentage points in the past two months on concern that Europe's leaders would be unable to prevent its sovereign-debt crisis from infecting bank balance sheets and freezing credit markets.
BlackRock joins Morgan Stanley and JPMorgan Chase & Co. in favoring securities that last month had their worst monthly return since November 2008, even as default rates remained at about 25% of their historical average.
“The high-yield market is in a good space,” Mr. Keenan said. “Balance sheets today look better than they did in 2006 and 2007.”
BlackRock, which manages $3.66 trillion in assets, is targeting bonds of speculative-grade companies involved in energy, mining, oil, natural gas, cable and wireless operations, he said.
BlackRock is largely shunning debt of retail restaurants and supermarkets, which are more susceptible to an economic slowdown.
'VISIBLE CASH'
“You want companies that have more stable and visible cash flow streams so their earnings quality is a lot higher and more stable to withstand economic downturns,” said Mr. Keenan, who manages the $5.4 billion BlackRock High Yield Bond Portfolio, which has beaten 89% of its peers over the last five years. Those are the companies to target for “high-single-digit yields” and “what we think is longer-term, relatively lower risk.”
Investors increasingly have purchased high-yield bonds since spreads expanded to 7.64 percentage points Sept. 12, the most since Nov. 30, 2009, Bank of America Merrill Lynch index data show. Funds that buy the debt, ranked below Baa3 by Moody's Investors Service and less than BBB- by Standard & Poor's, reported inflows of $210 million two weeks ago, following outflows of $6.4 billion last month, JPMorgan research shows.
Defaults could reach a peak of 6% if the United States goes into another recession, compared with up to 15% during prior downturns, JPMorgan analysts led by Peter Acciavatti, the top-ranked high-yield strategist in Institutional Investor magazine's annual poll, wrote in a Sept. 16 report. Relative yields on high-yield bonds are implying default rates of 7.4%, six times the current pace of 1.2%, the analysts wrote.
DEFAULT RATES
The U.S. corporate default rate fell to 2.1% last month, from 2.3%, Moody's data show. Relative yields on junk bonds are pricing in the worst five-year cumulative default rate on record, according to a Morgan Stanley report published Sept. 4.
“The spreads are factoring in a pretty draconian scenario in the economy,” Mr. Keenan said.
Although high-yield bonds are a good relative investment, it “may not be a good short-term trade, because of policy risks,” he said.
“There's still a tremendous amount of systemic risk,” Mr. Keenan said.
The U.S. economy may end the year with an expansion rate of 1.6%, compared with 3% for 2010, according to the median estimate of 66 economists surveyed by Bloomberg.
High-yield bonds lost 0.4% this month, following declines of 4% in August, Bank of America Merrill Lynch index data show.
Notes graded BB by S&P and Moody's have outperformed the lowest-rated junk debt for five consecutive months as investors have continued to shed risk tied to companies relying most on economic growth to reduce debt, the data show.
Bonds rated CCC and lower have lost about 10.6% since the end of April, following a rally that in-creased the value of the debt by 123.9% since the end of 2008.
