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It sounds like the Fed's plan for eventually tapering QE (which is currently running at $120 bil/month) may be aided by the arrival of the free spending Dems and their MMT fiscal spending plans. This will take up the slack in stimulus as the Fed tapers QE. So that's another reason for the Feds to favor a Dem sweep in this election.
Using fiscal policy (increasing deficit spending and decreasing taxes)
would be similar to the 2014-15 period when the Fed was fairly desperate to start tapering down QE and reduce its own bloated balance sheet. They got House Speaker Paul Ryan to reverse course and end the 'Sequester', and begin running much bigger deficits. Then a few years later came Trump's big tax cuts.
The stimulating effect from these bigger budget deficits and the tax cuts provided cover for the Fed's attempt to normalize interest rates and reduce its balance sheet. Nice try, and it almost worked, but the economy began weakening, made worse by Trump's trade war with China, so the Fed had to throw in the towel on rate normalization. Then the 'repo' problem appeared in the Fall of 2019, and the Fed had to restart QE. Of course then came Covid and mega QE.
Using the spendthrift Dems and MMT while the Fed tapers QE might work for a while, but how long can the US run deficits of 2-3 trillion/year before faith is lost in the dollar? Clearly the system is circling the drain, but they can probably keep it circling for a number of years before there is a final crisis. All the trillions in liquidity may keep the stock market buoyant, but looking longer term it seems best to start transitioning to hard assets like gold, land, rural real estate, etc.
>>> Fed looks to 2013 for future strategies in tapering asset purchases
Yahoo Finance
by Brian Cheung
January 7, 2021
https://finance.yahoo.com/news/fed-looks-to-2013-for-future-strategies-in-tapering-asset-purchases-120448382.html
The Federal Reserve may dust off its playbook from 2013 if it shifts to tapering its aggressive asset purchase program.
Currently, the central bank is snatching up $80 billion in U.S. Treasury bonds and $40 billion in agency mortgage-backed securities per month.
The Fed’s latest guidance, from Dec. 16, noted that the so-called quantitative easing program would continue at least at that pace until the economy looks like it has made “substantial further progress” in the recovery.
But minutes from that December meeting note that a “number” of Fed officials are already thinking about how to wind down those purchases once that “progress” is made.
Those unnamed Fed officials said they would like to “follow a sequence similar to the one implemented during the large-scale purchase program in 2013 and 2014.”
At the time, then-Fed Chairman Ben Bernanke announced in December 2013 that it would be notching down its monthly pace of purchases from $85 billion per month to $75 billion per month. The Federal Open Market Committee (FOMC) clarified that the program was not on a “preset course,” and that further slowing those purchases would only happen if the economy was ready for it.
JPMorgan’s Michael Feroli noted that the FOMC minutes for December 2020 show that the Jerome Powell-led Fed would similarly like to have its purchases “set on cruise control.” Feroli wrote Wednesday that the 2013 and 2014 reference also means the tapering process could go on for about 10 months. Analysts at Evercore ISI project a 12-month taper.
“Guidance on asset purchases remains pretty vague at this point and it appears future decisions will remain discretionary,” Feroli said in a note.
A cautionary tale
But the 2013 experience is also a cautionary tale of the perils of Fed communication.
The Fed had been debating its approach to tapering for months leading up to the December announcement, and Bernanke in May 2013 let it slip that a “step down” in quantitative easing could happen. The remark triggered a spike in bond yields and falling stock prices in an episode now known as the “taper tantrum.”
“A taper tantrum is now a real risk,” Jefferies economist Aneta Markowska told Yahoo Finance on Wednesday, forecasting a U.S. 10-year Treasury bond reaching 2% by the end of 2021.
The 10-year broke through the 1% mark on Wednesday morning, on the heels of the Georgia runoff election results that resulted in Democratic control of the Senate.
For the Fed’s part, policymakers are not yet on the same page about the timing for when to kick off any tapering. The minutes noted that two Fed policymakers favored a more stimulative quantitative easing program that would tilt its purchases toward longer-dated bonds.
In remarks this week, Fed officials sent mixed messages on whether or not the next steps on asset purchases would be a ramping up or a winding down of the program.
“These comments created an unhelpful mini-cacophony that is more than usually problematic given subsequent political and fiscal developments,” Evercore’s Krishna Guha and Ernie Tedeschi wrote Wednesday.
The analysts advocated for Fed leadership to more clearly signal its intention on where quantitative easing is headed, marking now as a “sensitive moment” for the Fed.
The next scheduled policy-setting meeting will be Jan. 26 and 27.
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>>> Fed policy in 2021: Three things to watch
Yahoo Finance
Brian Cheung
December 28, 2020
https://finance.yahoo.com/news/federal-reserve-policy-in-2021-3-things-to-watch-113851008.html
It has been a long year for the Federal Reserve.
Since the first cases of COVID-19 in the United States, the central bank has slashed interest rates to zero, restarted its quantitative easing program, and opened up a slew of emergency loan facilities to backstop markets ranging from corporate debt to municipal bonds.
The beginning of the new year will be a critical inflection point for the U.S. economy. With case counts surging across the country, the Fed will attempt to bridge the next few months until widespread vaccination and herd immunity are achieved.
With interest rates near-zero and likely to stay there through the end of 2023, that means a need for other, unconventional monetary policy tools.
“There is more that we can do, certainly,” Fed Chairman Jerome Powell said December 16, adding that the second half of 2021 should see the economy “performing strongly.”
So what should markets be watching for from the Federal Reserve next year?
Emergency loan facilities
As COVID-19 began ripping through the country in March, the Fed moved to backstop several financial markets and stand up new programs offering credit to business borrowers.
Several of the programs will expire on December 31, at the order of U.S. Treasury Secretary Steven Mnuchin. But if economic conditions worsen next year, the Fed will face a difficult question: whether or not to re-open the facilities.
Three programs in particular will pose legal and political challenges to the Fed: the Municipal Liquidity Facility (loans to state and local governments), the Main Street Lending Program (loans to small- and medium-sized businesses), and the Corporate Credit Facilities (liquidity for corporate debt markets).
Language buried in the over 5,000-page government spending bill, which includes COVID-19 relief, would bar the Fed from either resurrecting those three programs or anything the “same as” those programs.
But current and former Fed officials have been vocal about their desire to keep those emergency programs available into 2021.
A Treasury Secretary Janet Yellen, pending Senate confirmation, could work with the Fed on other programs in the future. But the new statutory limitations may entangle the Fed in political backlash if it attempts to toe the line on re-opening something close to the three facilities in question.
"How effective that narrowing will be, in terms of freeing up the Fed to do what it most wants to do? It depends on how aggressive the Fed's lawyers want to be,” said Columbia Law professor Kathryn Judge.
Quantitative easing
The Fed’s massive pile of assets totals more than $7 trillion, the consequence of an aggressive pace of quantitative easing in the face of the crisis. The latest guidance from the Federal Open Market Committee makes it clear that its balance sheet will only get bigger until “substantial further progress” is made on the recovery.
More specifically, that means at least $120 billion in monthly purchases ($40 billion in agency mortgage-backed securities and $80 billion in U.S. Treasuries).
“Any time we feel like the economy could use stronger accommodation, we would be prepared to provide it,” Powell said on December 16.
But the Fed has not clarified exactly how it could adjust those purchases. Powell entertained the idea of, for example, targeting longer-dated purchases to push down longer-term borrowing costs.
Similarly, the Fed has not spelled out what a better-than-expected 2021 may mean for its asset purchases. “Substantial further progress” may mean a tapering of its asset purchases would come before the Fed lifts off from zero-interest rates.
The imprecise language, however, will keep Fed watchers and investors guessing on where inflation and unemployment will have to land before quantitative easing is pared back.
“It’s hard to infer when tapering will begin, but we would still pin that sometime around the end of next year,” JPMorgan’s Michael Feroli wrote on December 16.
Reflation may be around the bend
For both interest rate policy and quantitative easing, the Fed will be using inflation as its guiding star to get to the destination of an economy at maximum employment.
In the face of the downside risk of rising COVID-19 cases, the Fed hopes that widespread vaccination and a return to normal will spur consumption that could bring some modest price increases.
A new policy adopted by the Fed in August articulates that the Fed would tolerate inflation “moderately” above its 2% target, meaning that reflation in a possible second half recovery would not trigger an interest rate hike.
Core personal consumption expenditures, the Fed’s preferred measure of inflation, clocked in at just 1.4% in November.
The end game is to keep policy accommodative and give the economy ample time to pull the unemployed back into jobs. As of November, the economy remained 9.8 million jobs short of its pre-pandemic level in February.
“We are committed to allowing the economy to run until we find out what maximum employment means experientially,” San Francisco Fed President Mary Daly said in September.
Constance Hunter, chief economist at KPMG, told Yahoo Finance that she would not expect a rate hike for another year or year and a half.
“A lot of this depends on how broad-based the recovery is, but assuming we can get some reflation going then that would mean they might start changing their language and changing their asset purchases so that we can have slightly tighter monetary conditions going into 2022,” Hunter said.
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>>> Bets on World of Negative Interest Rates End With Capitulation
Bloomberg
by Ruth Carson and Greg Ritchie
December 15, 2020
https://finance.yahoo.com/news/bets-world-negative-interest-rates-084540722.html
(Bloomberg) -- At the height of the pandemic, it seemed only a matter of time before negative interest rates -- the last resort of central banks -- ruled global markets.
A controversial strategy that’s yielded mixed results in the euro-area and Japan, traders still piled on bets earlier this year that central banks from New Zealand to the U.K., and even the U.S., were destined to follow suit. The three were among those that most aggressively cut rates through the worst of the virus-induced lockdowns. Yet all ultimately stopped short of going negative.
Traders now see a sub-zero move as increasingly unlikely, with policy makers largely favoring a “new conventional” mix of bond purchases and sector-specific aid programs. Of course, trillions of dollars of debt continue to trade with negative yields, effectively guaranteeing a loss for those who hold them to maturity. But with optimism returning about global growth, bond investors are shifting their attention to bets that yields will go higher, not lower.
“Central banks who don’t already have negative interest rates are going to be very cautious about crossing that rubicon,” said James Ashley, head of international market strategy at Goldman Sachs Asset Management. If policy makers need to prop up growth, “would it not be more prudent simply to rely on the unconventional tools like large scale asset purchases.”
Bold Experiment
Considered one of the boldest monetary experiments of the 21st century, negative rates were adopted in the wake of the financial crisis to drive borrowing costs lower and penalize banks that hoard cash rather than lending it out. The consequences for bond markets were far-reaching and long-lasting as trading was stymied and yields tumbled. The world’s stockpile of negative-yielding debt climbed above $18 trillion this month, a record, with rates on Spanish 10-year bonds sliding below 0% for the first time.
But despite the sub-zero strategy, both Europe and Japan have seen muted growth and failed to boost inflation to central banks’ targets. In fact, negative rates may have eaten into bank profits and hurt savers. As Federal Reserve Chairman Jerome Powell put it in May, “the evidence on negative rates is mixed.”
“The Fed has investigated a lot of BOJ and ECB policies,” said Kenta Inoue, senior market economist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo. “At this point in time, there is no evidence suggesting that negative rates policy has a positive impact on the economy as well as markets.”
In a way, the holdout central bankers were saved from having to make the decision to go negative by both the success of alternative policies and an improvement in the global economic backdrop. The flood of liquidity to the financial system -- spearheaded by the Fed -- pushed borrowing costs lower, and rapid progress on vaccine development brought forward expectations of a return to normal.
Positive Shift
In money markets, traders have erased bets on negative rates next year in both the U.S. and New Zealand. And while their U.K. counterparts still expect rate cuts to combat the economic blow dealt by the coronavirus and Brexit, the Bank of England is seen stopping at zero.
Indeed, higher bond yields are now seen in the U.S. and New Zealand, with some strategists from Bank of America to Societe Generale looking for 10-year Treasuries to advance toward 1.5% by the end of 2021.
The vocal pushback from U.S. policy makers on the likelihood of negative rates and economic optimism have seen investors switch to bets on a steeper yield curve, albeit with limits. The benchmark Treasury yield has about tripled from its March low to 0.90% Tuesday.
“Since the Federal Reserve has signaled that it would not cut interest rates below zero, Treasuries have a floor at 0%,” said Saxo Bank strategist Althea Spinozzi. “2021 is going to be all about a yield-curve steepener.”
New Zealand Story
The situation is similar in New Zealand. China’s economic rebound, the Reserve Bank of New Zealand’s more favorable outlook on the economy and a new lending program have slashed expectations for even one more rate move in Wellington, let alone a reduction below zero. The RBNZ has a record-low rate of 0.25%.
Swap markets are pricing just a 30% chance of a 25 basis point cut by the end of 2021, after pricing in almost 50 basis points of cuts in November. And the 10-year government bond yield was trading around 0.87% on Tuesday, about double the September low of 0.44%.
“The hurdle for doing negative rates is going to be very high,” said Bank of New Zealand strategist Nick Smyth. New Zealand bonds are losing their premium to peers and there’s the potential for 10-year yields to climb to 1.5% if Treasuries retreat, he added.
Brexit Blues
Still, the risk of a no-deal Brexit could revive bets on negative rates in the U.K. Although the BOE is currently seen lowering rates by 10 basis points in early 2022, pricing has see-sawed with Brexit headlines, with traders betting on a cut as soon as May last week.
The move comes after Monetary Policy Committee member Michael Saunders flagged room for more cuts, and colleague Silvana Tenreyro said evidence is “supportive” of a sub-zero rates policy.
“We see the BOE taking the bank rate negative next year,” said Peter Schaffrik, a global strategist at RBC Europe Ltd. “Even a Brexit deal is a huge disruption from the status quo, so the odds of negative rates will be lower but not by a lot.”
To be sure, BOE Governor Andrew Bailey has made a point that doesn’t chime with the market movements: that sub-zero rates might be more effective during an economic recovery rather than a slump. Ranko Berich, head of market analysis at Monex Europe Ltd., finds bets on negative rates rising in tandem with expectations of a no-deal Brexit puzzling for this reason.
“The BOE’s own communication has made clear the MPC views negative rates as a tool best used at a time when banks are less worried about balance sheet risks, ideally the initial upswing phases of a recovery,” he said. “This suggests they would be highly unlikely to take rates negative as a knee-jerk reaction to a no-deal Brexit, which is precisely the kind of shock that would get banks worries about balance sheet risks.”
For now, though, the market is being driven by Brexit talks. Concern about the impact of no-deal on the U.K. economy has kept a lid on the nation’s bond yields, with gilts’ performance regularly out of step with peers. The 10-year benchmark yield traded at around 0.24% Tuesday, having fallen as low as 0.15% last week, and investors see more downside as a distinct possibility.
“Gilts offer limited protection, given yields are already low, but they’ll still fall further in a bad Brexit outcome as negative rates becomes the base case,” said John Roe, head of multi-asset funds at Legal & General Investment Management. “We don’t see negative interest rates as a problem per se. We just see it as an outcome that’s positive for gilts, which means it’s dangerous to be short.”
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>>> The Bull Market That Won’t Die
BY JAMES RICKARDS
OCTOBER 28, 2020
https://dailyreckoning.com/the-bull-market-that-wont-die/
The Bull Market That Won’t Die
Investors have been hearing for years that “interest rates are near all-time lows,” and “rates have nowhere to go but up,” and finally, that “the bond bear market is right around the corner.”
These warnings have come from notable bond gurus including Bill Gross, Jeff Gundlach and PIMCO’s Chief Investment Officer Dan Ivascyn.
Investors are told that the time has come to dump bonds, short them if you can, and brace for much higher interest rates.
There’s only one problem with these warnings. The bond gurus have been dead wrong for years, and they’re wrong again now. Rates are going lower, and the bond market rally that began in 1981 has further to run. The bull market still has legs.
To paraphrase Mark Twain, reports of the death of the bond market rally have been “greatly exaggerated.”
The key is to spot the inflection points in each bear move and buy the bonds in time to reap huge gains in the next rally.
That’s where the market is now, at an inflection point. Investors who ignore the bear market mantra and buy bonds at these levels stand to make enormous gains in the coming rally.
“The Much Feared Bond Bear Market Never Materializes”
Let’s look at the record. The 10-year U.S. Treasury Note had a yield-to-maturity of 3.64% on February 11, 2011. That soon fell to 1.83% by September 23, 2011. Then the yield spiked to 2.23% on March 16, 2012. It fell back again to 1.46% on June 1, 2012.
Yields spiked again to 3.0% on December 27, 2013. Then yields fell back to 1.68% by January 30, 2015. And, so it continued through 2016 and 2017. Yields staged one last major back-up reaching 3.22% on October 5, 2018, before crashing once again to 0.54% on July 31, 2020.
Notice the pattern? Yes, yields are back up with some regularity. But they have never broken through the 3.25% level in nine years. The much feared bond bear market never materializes.
When yields get above 3%, the economy stalls out, disinflation takes over, the Fed panics and either “pauses” rate hikes or cuts rates resulting in yields coming back down to earth. Every time yields fall, bond investors make huge capital gains.
That’s exactly why the opportunity to go long Treasuries is so attractive. With all of the big players (hedge funds, banks, wealth managers) leaning on one side of the boat, it only takes a small perturbation causing lower yields and higher prices to trigger a massive short-covering rally, where these short investors scramble to exit their positions and buy bonds to cut their losses.
That’s not all. This technical history exhibits a pattern called “lower lows.” The rate spikes run out of steam around 3%, but each rate collapse goes lower than the one before. The history of rate bottoms is 1.46% on June 1, 2012, 1.36% on July 8, 2016, and the recent low of 0.54% on July 31, 2020.
Every time the bears say yields are going to the moon, they crash to a new low. That means bigger gains for investors.
Basic Bond Math
A bit of bond math is always helpful in these discussions since it’s counterintuitive for many investors. Yields and prices move in opposite directions. When bond yields go up, bond prices go down. When bond yields go down, bond prices go up.
Investors hoping for higher yields may not realize that the bond prices in their portfolio go down when that happens.
The best trading strategy is to buy a bond just when yields spike, and then hold it as yields fall back down to earth. That way, you keep the high yield on your bond and accrue huge capital gains as market yields decline. You can hold the bond to maturity, of course, but you can also sell it for a gain, move to the sidelines with cash and buy a new bond when yields get toppy again. Wash, rinse and repeat.
There’s another bit of bond math that is not intuitive to most investors. It’s called convexity or duration. In plain English, it means that as interest rates get lower, the capital gains get larger for each basis point decline in rates.
As an example, rates can decline from 3.50% to 3.25%. They can also decline from 1.00% to 0.75%. In each case, interest rates dropped by the same 0.25%. And, in each case, an outstanding bond would realize a capital gain.
But, the capital gain is larger in the second case than the first. Not all interest rate declines are created equal. Gains are bigger when rates are lower. Right now, rates are quite low, so the potential for capital gains is spectacular.
But, with rates so low already, what is the potential for rates to fall even more?
Rates on 10-year Treasuries rose from 0.513% on August 4 to 0.848% on October 22. Rates are 0.768% as of today. Right now, my models are telling me that bond yields will continue to fall, which means that bond prices will continue to rise.
Don’t Buy Into the Consensus
What’s been driving this increase in rates? The answer is simple. Markets expect a new deficit spending stimulus package from Congress. The package is still under negotiation, but the expectation is that it will be around $2 trillion, comparable to the $3 trillion of spending packages passed between March and June, during the worst stages of the pandemic.
Markets expect that this much new debt will flood the markets with new Treasury borrowings, which will drive bond prices lower. Markets also expect that this much stimulus will be inflationary because the Fed may have to monetize the new debt. The combination of more supply with a higher risk premium for inflation will result in much higher yields.
Both assumptions are probably wrong. The spending package depends on the election.
Democrats are confident that Joe Biden will win, so they are holding out, both to avoid giving Republicans a pre-election win and to get a better deal under President Biden.
Republicans take the opposite view and are holding out for a more conservative package under a reelected President Trump. The result is a stalemate.
My forecast is that Trump will win, and markets will be disappointed at the size (and spending priorities) of any package that results. This will cause rates to crash again.
Too Much Debt for Stimulus to Work
Even if a large spending package passes in the next few days or shortly after the election, it will not have the inflationary impact markets expect. Congress knows how to spend, but they do not know how to provide stimulus.
In fact, stimulus in the Keynesian sense is impossible when government debt levels are 130% of GDP. Research shows that any stimulus effect goes into reverse when debt-to-GDP levels pass 90%.
What you end up with is more spending, higher debt, but lower growth. Everyday Americans respond not by spending more but by saving more in anticipation of higher taxes or inflation down the road.
The short-term impact of that is not inflation, but disinflation or outright deflation. That means lower rates and bigger capital gains for Treasury bond investors.
As for rates being “low,” they’re not. It’s true that nominal interest rates (the kind you see on screens and TV) are near all-time lows. But real interest rates (nominal rates minus inflation) are quite high by historical standards. Real rates have to go much lower to help growth.
With inflation dropping, that means nominal rates have to go deeply negative in order to get real rates low enough to help. My forecast is for 10-year Treasury note rates to go to negative 0.50% or lower over the next year. That means large capital gains for investors in Treasury bonds.
Don’t go along with the crowd on this one. If you’re on the wrong side of this overcrowded trade, you could get trampled.
Regards,
Jim Rickards
for The Daily Reckoning
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>>> Bond Defaults Deliver 99% Losses in New Era of U.S. Bankruptcies
Bloomberg
By Jeremy Hill and Max Reyes
October 26, 2020
https://www.bloomberg.com/news/articles/2020-10-26/bond-defaults-deliver-99-losses-in-new-era-of-u-s-bankruptcies
Market prices, derivative auctions imply debt may be worthless
High borrowings, weak protections leading to low recoveries
Three cents. Two cents. Even a mere 0.125 cents on the dollar.
More and more, these are the kinds of scraps that bondholders are fighting over as companies go belly up.
Bankruptcy filings are surging due to the economic fallout of Covid-19, and many lenders are coming to the realization that their claims are almost completely worthless. Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies -- if that.
While few could have foreseen the pandemic’s toll on the economy, the depth of investors’ pain from corporate distress was all too predictable. Desperate to generate higher returns during a decade of rock-bottom interest rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earnings projections. Corporations, for their part, took full advantage and gorged on astronomical amounts of debt that many now cannot repay or refinance.
It’s a stark reminder of the long-lasting repercussions of the Federal Reserve’s unprecedented easy-money policies. Ultralow rates helped risky companies sell bonds with fewer safeguards, which creditors seeking higher returns were happy to accept. Now, amid a new bout of economic pain, the effects of those policies are coming to bear.
Debt issued by the owner of Men’s Wearhouse, which filed for court protection in August, traded this month for less than 2 cents on the dollar. When J.C. Penney Co. went bankrupt, an auction held for holders of default protection found the retailer’s lowest-priced debt was worth just 0.125 cents on the dollar. For Neiman Marcus Group Inc., that figure was 3 cents.
CDS Sadness
Credit default swap auctions portend steeper-than-usual losses
The loose lending terms that investors have agreed to mean that by the time corporations file for bankruptcy now, they’ve often exhausted their options for fixing their debt loads out of court. They’ve swapped their old notes for new ones, often borrowing against even more of their assets in the process. Some have taken brand names, trademarks, and even whole businesses out of the reach of existing creditors and borrowed against those too. While creditors always do worse in economic downturns than in better times, in previous downturns, lenders had more power to press companies into bankruptcy sooner, stemming some of their losses.
The pandemic is upending industries like retail and energy, making it unclear how much assets like stores and oil wells will be worth in the future. The underlying problem for many companies, though, is that they have astronomical levels of debt after borrowing with abandon over the previous decade, then topping up with more to get them through the pandemic.
For bondholders, the kind of liabilities that companies have added makes the problem worse. Loans have been a particularly cheap form of debt for many companies over the last decade. Those borrowings are usually secured by assets, leaving many corporations with more secured debt than they’ve had historically. That means that unsecured bondholders end up with less when borrowers go broke.
“We’ll see companies gradually hitting the wall -- it’s just a question of when and how fast,” said Dan Zwirn, founder of Arena Investors, a $1.7 billion investment firm with an emphasis on credit. “There’s just going to be way more downside.”
Record Lows
The recent low values for bonds in credit derivatives auctions signal that in future bankruptcies owners of unsecured bonds, not to mention loans, may suffer a bigger hit than usual, according to research from Barclays Plc. The median value for companies’ cheapest debt in credit derivatives auctions this year is just 3.5 cents on the dollar, a record low and far below the 23.4 cent median for 2005 through 2019.
The value of a company’s bonds in an auction for credit derivatives payouts doesn’t necessarily equal how much money bondholders will actually recover when a bankruptcy is complete. But lower auction values do tend to correlate to lower recoveries, according to Barclays. Lower market values also reflect investor concerns.
The auctions represent the value of a company’s cheapest unsecured bond, although usually most of a borrower’s unsecured notes trade around the same price in bankruptcy, according to Barclays. When a company defaults or files for bankruptcy, an investor that bought a credit default swap receives a payout equal to 100 cents on the dollar minus the auction value of the cheapest-to-deliver security.
Loan Pain
It’s not just bond investors that will suffer from low recoveries. Amid the pandemic downturn, loan investors could find themselves losing 40 to 45 cents on the dollar, compared with historical averages of 30 to 35 cents, according to Barclays.
One factor that is hurting money managers is the erosion of investor protections known as covenants, as more and more high yield and leveraged loan deals are covenant-lite, meaning they feature minimal such safeguards. When corporations had more restrictive covenants, borrowers had less room to fix their debt outside of court, sending them into bankruptcy closer to the first sign of trouble.
Now companies have more leeway to seek extra financing when they’re in trouble, and to give lenders providing additional funds the right to jump to the front of the line if the company does go bankrupt.
“Covenant-lite paper usually means by the time you get back to the table with the borrower, the house is on fire,” said Sanjeev Khemlani, a senior managing director at FTI Consulting. “All of that extra time you had before, that’s just gone away.”
Oaktree Deal Crushed a Leveraged Loan and Exposed Market’s Woes
Investors that bought a J. Crew Group Inc. term loan at par back in 2014 may have thought they were making a relatively safe bet, since it was secured debt. When the company started struggling a few years later, it moved intellectual property including its brand name into a new entity, a move enabled by relatively loose covenants.
The company then exchanged some of its existing bonds for new notes secured by the intellectual property as well as preferred stock and equity in its parent company, as part of a broad restructuring. Loan investors ended up suffering: after the company filed for bankruptcy in May, the 2014 obligation was worth less than 50 cents on the dollar, according to Bloomberg loan valuation estimates. (J. Crew exited bankruptcy in September.)
FTI’s Khemlani, who advises lenders with senior claims on borrowers’ assets, said investors should make an effort to “put some teeth” into their agreements with borrowers now as they fall into distress, regaining some lost protection.
In addition to shifting assets, companies have also been doing more distressed exchanges in recent years, where troubled corporations offer creditors new, debt that often ranks higher in the repayment pecking order in exchange for relief like lower principal or later maturities or both. Creditors that participate can stem their losses in the event of a bankruptcy, but investors that sit the deal out can end up worse off.
The popularity of distressed exchanges has also contributed to a general rise in secured debt in companies’ capital structures. That means that more investors -- holders of loans and secured bonds -- are fighting for the same scraps when a company files for bankruptcy. Almost 20% of the debt in the U.S. high-yield bond market is now in some way secured, according to Barclays, versus just 6% in 2000. The number of businesses that had taken out just loans and no other form of debt almost doubled between 2013 and 2017, according to JPMorgan Chase & Co. data.
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>>> How to invest for income now
Tactical multi-asset investing takes on low rates and bad news
BY ADAM KRAMER, PORTFOLIO MANAGER,
FIDELITY VIEWPOINTS
05/01/2020
Key takeaways
Multi-asset income strategies may help investors seek income despite low interest rates.
Professional investment managers may find opportunities when markets misprice assets in reaction to bad news.
Opportunities exist now in investment-grade corporate bonds, high-yield bonds, dividend-paying stocks, convertible bonds, and Treasury inflation-protected securities.
With interest rates at historic lows and some companies reducing or eliminating dividends, it's a challenging time for investors who seek income from their portfolios. Challenging, though, is not the same as impossible. A professionally managed, tactical approach to income investing that can look for opportunities in a wide variety of asset classes may help income-seeking investors achieve their goals, despite low rates.
In fact, economic uncertainty and anxiety about the spread of COVID-19 make this a good time for tactical investing. That's because when uncertainty is high, markets may temporarily misprice assets based on short-term events and overlook other factors, such as how much investors might earn over a longer term on those assets.
For professional managers who can identify those mispricings, the combination of abundant bad news and the freedom to invest in a wide variety of assets can present opportunities. Rather than overreact to bad news, tactical managers can seek assets they believe have the potential to outperform if the bad news "turns out not to be so bad after all." Even if reality turns out as negative as markets expect, prices shouldn't fall much because investors anticipated it. Keeping an eye out for mispricings can also help avoid assets where not enough bad news may be priced in and prices are too high.
Looking for opportunities
The forces that drive financial markets are always in motion. Economic growth increases and slows. Investors' enthusiasm for certain asset classes or companies rises and falls. New technologies arise, while older ones fade away. Unforeseeable events can act on global economies in unexpected ways. Because market conditions constantly change, the investments that deliver the highest returns today may not be the ones that do so next month or next year. That's why multi-asset income strategies that can invest across a wide variety of asset classes may be able to deliver more consistent returns and a better balance between risk and return than those with fewer options to choose from.
How yields and risks of popular investment choices compare
The data in the chart is described in the text.
For illustrative purposes only.
Source: Fidelity Investments
The chart above depicts general long-term directional and ranking relationships among a number of asset classes on the dimensions of yield and beta. Beta is estimated in comparison to US common stocks as represented by the S&P 500 index. The relationships and relative rankings among these asset classes will vary over time.
Finding opportunities now
As the US Treasury, Federal Reserve, and federal government continue to be pragmatic and supportive of the economy, the coronavirus pandemic has created opportunities within many income-oriented US asset class. As concerns over the economic impact of the virus's spread prompted many investors to sell assets, prices of many bonds as well as stocks dropped to levels not seen since the global financial crisis. Assets sold off with little regard for fundamentals and since then, professional investment managers have been buying those that offer income and value on the expectation that if events turn out better than expected, their prices could rise in addition to paying interest and dividend income.
While many companies' operations have been severely reduced, dividend-paying US large-cap stocks present opportunities for managers of income strategies who practice careful security selection and seek companies with strong balance sheets that pay sustainable dividends. Many of these stocks' prices fell significantly during widespread selling that accompanied the spread of COVID-19 around the world. They include consumer staples, pharmaceuticals, and information technology companies, and also companies in sectors such as materials and energy that have historically performed well as the economy emerges from recession.
Some dividend-paying stocks related to the transportation of oil and refined products also offer opportunities. Oil tanker operators are an example of how the ability to spot mispriced assets can benefit income-seeking investors. Theirs were among the first stocks to move lower as the coronavirus spread in China and oil demand fell. Oil production cuts are generally a negative for oil tankers because there's less cargo for them to carry. However, demand and prices have fallen faster than production, and oil companies are storing crude oil on ships. That means more need for ships than expected. Despite plunging global oil demand, these companies will soon start declaring their first quarter dividends and should have a much better situation than previously expected.
Preferred stocks have been very expensive but are now priced near their historical averages. Most US preferreds are in banks which are in much better shape than they were during the financial crisis.
Remember, though, as we've seen this year, stock markets are volatile and can decline significantly.
Many high-quality companies' investment-grade corporate bonds offer opportunities, including those from defense contractors, regulated utilities, and large US banks. Many of these bonds are now selling at discounts. Unusually, these bonds' prices fell along with stocks during the March COVID-19-related sell-off. Since then, prices of many highly rated bonds have recovered, but BBB-rated investment-grade corporate bonds offer both attractive prices and income, with many yielding near 4%, as of April 29, 2020.
Some high-yield bonds with credit ratings of BB and B also present opportunities, particularly those issued by cable, telecommunications, packaging, and industrial companies. Many of these bonds are selling at a discount, with yields of 6% and 9%, respectively, as of April 29, 2020.
To be sure, bonds of less than investment-grade quality involve greater risk of default or price changes due to changes in the credit quality of the issuer. Because of these risks, careful security selection by professional managers is important.
Convertible bonds issued by companies in industries such as technology and health care, whose underlying stocks had been expensive are currently more reasonably priced, at close to their averages over the past 25 years. Many new bonds offering attractive yields are being issued as companies seek to adjust to the new COVID-19 reality.
Convertible bond prices can fall if interest rates rise and stock prices decline, but they are less sensitive to such changes than both stocks and traditional corporate bonds. While bad news can help create opportunities, too much of it can have the opposite effect. Too much bad news has been priced into US Treasurys, which have rallied and no longer look attractive. While they can act as hedges to protect investors in down markets, they currently offer little yield.
Treasury inflation protected securities (TIPS), which adjust to the consumer price index, can be an attractive alternative to Treasurys. When real yields move lower, TIPS have historically done well. In the COVID-19 world, financial markets are pricing in very little future inflation due to falling oil prices and reduced business and consumer spending. This is reflected in declining real yields which give TIPS a better balance between risk and reward than nominal Treasuries looking out over the next year or two.
Finding ideas
Investors interested in these strategies should research professionally managed mutual funds. You can run screens using the Mutual Fund Screener on Fidelity.com. Below are the results of some illustrative mutual fund screens (these are not recommendations of Adam Kramer or Fidelity).
Multi-asset class income funds
Fidelity funds
Fidelity® Multi-Asset Income Fund (FMSDX)
Non-Fidelity funds
BlackRock Multi-Asset Income Portfolio (BAICX)
American Century Multi-Asset Income Fund (AMJVX)
Invesco Multi-Asset Income Fund (PIAFX)
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>>> A ‘Buy Everything’ Rally Beckons in World of Yield Curve Control
Bloomberg
By William Shaw and Todd White
June 21, 2020
https://www.bloomberg.com/news/articles/2020-06-21/a-buy-everything-rally-beckons-in-world-of-yield-curve-control?srnd=premium
Fed and BOE may follow Japan, Australia in targeting yields
Move could boost bonds, credit, equities and carry trades
Federal Reserve Chair Jerome Powell said the usefulness of the policy “remains an open question” on June 10.
As central banks pump trillions into the world economy, investors are setting their sights on what could be the next big thing in global monetary policy: yield curve control.
The strategy, which involves using bond purchases to pin down yields on certain maturities to a specific target, was once deemed an extreme and unusual measure, only deployed by the Bank of Japan four years ago after it became clear that a two-decade deflationary spiral wasn’t going away.
No longer. This year, the Reserve Bank of Australia adopted its own version. And despite officials’ attempts to cool it, speculation is rife that the U.S. Federal Reserve and Bank of England will follow later this year.
Should yield curve control go global, it would cement markets’ perception of central banks as the buyers of last resort, boosting risk appetite, lowering volatility and intensifying a broader hunt for yield. While money managers caution that such an environment could fuel reckless investment already stoked by a flood of fiscal and monetary stimulus, they nonetheless see benefits rippling across credit, equities, gold and emerging markets.
“It depends on the form and the price but broadly speaking it’s the green light to carry on with the QE trade -- buy everything regardless of valuation,” said James Athey, who manages $3.1 billion at Aberdeen Standard Investments in London.
Boost for Bonds
While the BOE didn’t discuss yield curve control on Thursday, some analysts think it could ultimately target five-year notes at a rate of 0.1%, flattening the yields out until that maturity.
That could send money flowing into shorter maturity bonds and trigger a sell-off in volatility. Demand for shorter maturities could drive up rates on longer peers -- a mixed blessing for pension funds and life insurers, which could see their existing holdings devalued, but be able to buy new assets for less.
Pre-Curve Control
Talk of negative rates from BOE has held down short-end U.K. bond yields
Federal Reserve Chair Jerome Powell said the usefulness of the policy “remains an open question” on June 10. While most expect a low-yield target for shorter maturities, potentially as soon as September, Societe Generale SA sees a case for focusing further out the curve. Five- and seven-year Treasuries may rally if the Fed looks to go beyond controlling just the front end.
Where central banks set their target will be key, and could send assets swinging either way. A 50-basis-point target on the 10-year Treasury yield would spark a bond rally and flatten the curve alongside a probable rise in equities. However, a full percentage point could see bonds bear steepen and trigger a sell-off in shares, said Aberdeen Standard’s Athey.
Credit Surge
Capping interest rates would help by ensuring corporate borrowers continue to benefit from attractive financing rates. Lower yields in longer maturities would assist investment-grade companies, which tend to issue longer-dated debt than lower-rated borrowers. Meanwhile, junk borrowers would reap the rewards of the general boost to market sentiment.
Companies with high debt loads such as airlines and energy could get a lift, said Charles Diebel, who manages $2.6 billion at Mediolanum SpA in Dublin. U.K. banks could also gain as lenders will have escaped the crushing effect of negative interest rates.
Yields on company bonds have already benefited from policy support
“It will allow the whole rating spectrum of fixed income credits to borrow at incredibly cheap absolute levels during a time of much uncertainty and would certainly be very bullish,” said Azhar Hussain, head of global credit at Royal London Asset Management.
Carry Trade
Lower rates in the U.S. could weaken the dollar and help riskier currencies like the South African rand and Mexican peso. Carry trades involving the Indonesian rupee and the Russian ruble could also benefit, as well as Group-of-10 currencies like the Australian dollar and Norwegian krone, according to Vasileios Gkionakis, head of foreign-exchange strategy at Banque Lombard Odier & Cie SA in Geneva.
Traders in South Africa's currency love events that weaken the dollar
The move could also send dollars flowing into carry trades targeting U.S. assets. These could include mortgage-backed securities, as well as sovereign, supranational and agency bonds.
Bubble Risk
Of course, such a widespread bullish outlook comes with risks, especially at a time when asset valuations are near extremes. A rally in U.S. stocks has pushed estimated price-to-earnings to the highest in almost two decades.
Meanwhile, 10-year yields are negative for nine of 25 developed markets tracked by Bloomberg, while the rest stand well below their one-year averages. It’s a precarious bubble that could eventually burst, should the wall stimulus spur inflation down the road and eat into investors’ profits.
While most asset classes stand to gain from a global wave of yield curve control, investors may want to heed lessons and challenges from different regions.
Since the BOJ started the policy in 2016, it has largely succeeded in tethering the 10-year rate at around 0%. As for the RBA, it began pinning the three-year yield at 0.25% in March. Yields on longer maturity bonds rocketed then eased after the announcement, and the spread between three-year and 10-year yields remains around 30 basis points wider than in mid-February.
Introduction of yield curve control pushed Australia's bond curve steeper
For the European Central Bank, the challenge would be the multiple interest-rate curves under its remit. The ECB has acknowledged the importance of keeping borrowing costs low across all bond maturities, without committing to an explicit yield curve control policy.
Regardless, the notion that central banks are approaching some sort of curve control is here to stay. A key lesson from the 2008 crisis was that policy makers need to intervene quickly, and investors now expect them to consider any weapon at their disposal.
“Policy makers tightened up the banking system so much that the markets became too big to fail,” said Mark Nash, the head of fixed income at Merian Global Investors in London. “Now they have no choice but to keep them working.”
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>>> Brawls Erupt in U.S. Debt Markets After Borrowers Get Desperate
Bloomberg
By Sally Bakewell, Claire Boston, and Katherine Doherty
June 11, 2020
https://www.bloomberg.com/news/articles/2020-06-11/brawls-erupt-in-u-s-debt-markets-after-borrowers-get-desperate?srnd=premium
Credit-market feuds getting uglier, dirtier and more vicious
Weak covenants open door to asset transfers, other moves
A massive wave of corporate distress is pitting beleaguered companies against their lenders in brawls that are shaping up to be nastier than ever before.
Desperate firms and their private equity owners are seeking to take advantage of years of weakening creditor protections to help cut obligations and raise cash after the coronavirus outbreak brought businesses to a standstill. Be it via allowances written into borrowing documents when times were good or simply loopholes in deal terms, they’re siphoning collateral and transferring assets while pushing deeply discounted debt swaps onto investors, who risk seeing the value of their bonds and loans plunge if they don’t go along.
Still, money managers aren’t just rolling over. Credit powerhouses like GSO Capital Partners, BlackRock Inc. and HPS Investment Partners have lined up scores of lawyers and financial advisers to defend their interests, often finding themselves at odds with one another as they fight for the biggest piece of a shrinking pie. As the gloves come off, industry veterans say tensions are as high as they’ve ever seen.
“You have more and more aggressive people holding this stuff and private equity firms have gamed every nook of credit agreements,” said Dan Zwirn, chief executive officer of Arena Investors, which manages $1.4 billion. “As people get desperate, there are going to be a lot more of these.”
The conflicts underscore how the legacy of the last crisis is being felt as the current one unfolds. The Federal Reserve’s relentless interest-rate cutting and quantitative easing spurred a surge in demand for higher-yielding assets, helping risky companies sell debt with fewer lender safeguards. Now, amid a fresh bout of economic pain, the effects of those policies are coming to bear.
Corporate Stress
Global corporate default tally spikes as pandemic takes hold
One such fight recently played out between Sinclair Broadcast Group Inc. and its creditors.
The company through a subsidiary sold $1.8 billion of unsecured notes last year to fund the acquisition of Walt Disney Co.’s regional sports networks. Those securities have plunged as the pandemic left stations with no professional sporting events to televise.
Relatively loose provisions in the bond documents helped embolden Sinclair to pursue a debt exchange that asked holders to take a 40% haircut and swap into debt secured by the company’s assets.
Lenders late last month balked at the terms, and a group led by Shenkman Capital Management organized to block the exchange. The response from Sinclair was ominous: the company said it was weighing other options including a possible maneuver that would shift company collateral out of creditor reach if the exchange offer was not successful.
The potential moves were “threats” that appeared designed to pressure lenders, according to Covenant Review, which called the outstanding bond’s safeguards among the weakest it had ever seen.
“Issuers are being more aggressive in the way they are going about debt exchanges; they’re looking for additional ways to coerce bondholders that haven’t been interested in participating,” said Scott Josefsberg, an analyst at the debt research firm. “But investors are putting up a fight so far.”
Sinclair ultimately exchanged around 3.6% of eligible notes.
A representative for the broadcaster had no immediate comment, while Shenkman declined to comment beyond confirming its role leading the creditor group.
Read more: Unreadable fine print in leveraged loans sparks market backlash
Sinclair’s exchange offer was hardly the only one to provoke the ire of investors in recent weeks.
SM Energy Co.’s efforts to get creditors to swap their bonds into new securities at 50% to 65% of face value have faced significant pushback. With only about 10% of note holders agreeing to tender last month, the oil and gas driller struck a separate agreement with a group of creditors led by BlackRock.
The side deal was designed to backstop the exchange, and the BlackRock-led group got better terms for swapping its debt versus what was offered to other creditors. The move infuriated other lenders, who organized with law firm Weil Gotshal & Manges to oppose the deal.
Bondholders that accept the exchange must agree to eliminate almost all restrictive covenants on the existing debt, which would hurt anyone who doesn’t participate. The deadline for the tender has been extended to June 12.
SM Energy, BlackRock and Weil Gotshal & Manges didn’t respond to requests seeking comment.
Revlon Clash
Analysts have been warning investors for years that weakening protections would ultimately have costs as investors ceded more and more ground to borrowers. Yet despite the recent surge in corporate stress, a Moody’s Investors Service gauge of bond covenant quality remained near the weakest on record in April. A similar tracker for loans reached its lowest ever in the fourth quarter, the most recent data available.
Lender safeguards played a major role in Revlon Inc.’s contentious $1.8 billion debt overhaul last month.
Creditors including Brigade Capital Management and HPS had organized to block the company’s refinancing plan because it allowed the firm to siphon off collateral and use it to back new debt. Supporters of the plan included Ares Management Corp. and Angelo Gordon & Co.
The deal needed more than 50% of the holders signed on to close. At first, opposing lenders held a blocking position with a majority of the outstanding loan amount opting out. But Revlon secured a new $65 million revolving credit facility from the supportive lenders -- which the company says was permitted under its covenants -- ultimately giving it enough backing to push the deal through.
Some lenders continue to contest the transaction, arguing that Revlon needed the majority of debt holders of every tranche to agree, and maintaining that the company breached covenants when it moved certain intellectual property to secure a $200 million loan last year, according to people with knowledge of the matter.
Still any creditors that chose not to participate in the refinancing were demoted from having a first-priority claim on company assets to a third-lien claim.
“Revlon is strengthening its balance sheet and increasing liquidity to better deal with the issues at hand, including Covid-19,” Chief Financial Officer Victoria Dolan said in a statement to Bloomberg. “This group of objecting lenders is trying to block that. We are confident that we will overcome this effort to hurt our company.”
Representatives for Brigade, HPS, Ares and Angelo Gordon declined to comment.
Read more: Revlon lenders allege default with debt deal nearing close
Transactions involving collateral transfers have been among the most fiercely contested between creditors and private equity firms scrambling to protect their investments.
Paul Singer’s Elliott Management Corp. last month became locked in a fight with lenders of global bookings operator Travelport, which Elliott bought last year with Siris Capital Group. The owners shifted intellectual property estimated to be worth more than $1 billion to an unrestricted subsidiary -- putting it out of reach of the creditors -- to help it raise cash.
Lenders led by GSO demanded that Travelport unwind the transaction for violating indenture agreements, and declared the step a default. The owners, who argue it was permitted, told them they would reverse the asset transfer if the creditors provided roughly $500 million of new financing and rolled up some existing debt holdings at a discount.
The dispute has gotten so heated, Bank of America Corp. last month surrendered its role as administrator of Travelport’s loan to avoid taking a side in the feud, while Kirkland & Ellis recently resigned as the company’s legal representation, according to people familiar with the matter.
With the sides at loggerheads, the private equity owners supplied the financing themselves in a loan backed by the disputed collateral, a move that’s likely to further inflame the situation.
Representatives for Travelport, Elliott, Siris, GSO and Bank of America declined to comment, while Kirkland & Ellis didn’t have an immediate comment.
‘Fight Like Dogs’
Industry veterans say creditors should no longer be surprised when private equity sponsors use asset transfers, spinoffs, carve outs and other such moves following a number of high profile and hotly contested maneuvers in recent years.
“Anyone professing to be shocked by it probably hasn’t been around very long,” said Philip Brendel, a senior credit analyst at Bloomberg Intelligence.
Yet with creditors so far showing little appetite to push for stronger covenants in borrowing documents, market watchers warn to expect more brawls in the months and years ahead.
“Rates were suppressed long after they should have been; it drove yield hunger and a non-bank explosion that created misalignments,” Arena Investors’ Zwirn said. “Now they’re learning once again, there are consequences. We are at just the beginning of this thing. They’re going to fight like dogs to avoid those consequences.”
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>>> Why It’s Time to Rethink Bonds
Barron's
by Gail MarksJarvis
June 7, 2020
https://www.barrons.com/articles/with-rates-so-low-income-investors-need-to-rethink-bonds-51591404975?siteid=yhoof2&yptr=yahoo
Already-beleaguered income investors are facing a tough decade. Ten years ago, investors were bemoaning a 3.8% yield on the 10-year Treasury, because a decade before that, they were yielding 6.4%. Recently, 10-year Treasuries yielded 0.88%.
“We are at a pretty bleak starting point for income investors,” says Michael Fredericks, manager of the $16 billion BlackRock Multi-Asset Income Portfolio fund (ticker: BAICX).
Fredericks has analyzed decades of bond performance using the Barclays Aggregate Bond Index, or AGG, and found that the 10-year Treasury yield at the start of a decade gives a reliable clue to what’s to come during the next nine years. The starting Treasury yield is almost identical to the annual total return over the decade. For example, the 10-year Treasury was yielding 3.8% on Jan. 1, 2010, and the annualized return through the decade was 3.75%. “This suggests that with the 10-year Treasury yielding 0.8% today, the returns for the AGG over the next 10 years will likely be incredibly low,” he says.
“Advisors should be telling their clients that they aren’t going to generate the income they have in the past from Treasuries, or even corporate or high-yield bonds,” adds Adrian Cronje, chief investment officer of Atlanta financial advisory firm Balentine.
Investors—especially retirees and other conservative investors—need to shift how they view bonds. Instead of relying on bonds for income, investors should embrace bonds as ballast. That means settling for low yields from Treasuries and high-quality corporate and municipal bonds, while tapping total return in stock and bond portfolios for income.
Barron’s spoke to advisors, analysts, and fund managers to assess the best strategy for bond investors today. Here’s what they said.
Don’t overdo risk. Investors have gone further out on the risk curve, allocating larger portions of their portfolio to high-yield, emerging-market debt, and bank-loan funds. That risk taking hurt badly in the coronavirus market rout between Feb. 19 and March 23. Among some of the biggest exchange-traded funds, the iShares iBoxx $ High Yield Corp Bond (HYG) plunged 22%; the Invesco Senior Loan (BKLN) fell 21%; the iShares Preferred and Income Securities (PFF) lost 27%; and the (ICVT) dropped 24%.
“Most investors don’t need an allocation to bank loans, preferred stock, or convertibles,” says Morningstar analyst Alex Bryan.
One ETF, such as the iShares Core Total USD Bond Market ETF (IUSB), which invests in Treasuries, mortgage-backed securities, and investment-grade and high-yield bonds, could offer enough diversification. Alternatively, Bryan suggests mimicking the makeup of that fund with more specific ETFs, to more easily add or reduce positions in, say, high-yield.
Don’t ignore Treasuries. Yes, Treasury bonds are yielding next to nothing, but yields drop when prices rise—which means investors can still find that bonds offer steadiness, and possibly positive returns, when stocks fall. “I’m not using corporate bonds at the moment,” says Sue Stevens, an advisor in Deerfield, Ill. “The bond portion of a portfolio should just be safe.” The Vanguard Intermediate-Term Treasury ETF (VGIT) has gained 7.3% so far this year, Stevens notes, while the Vanguard S&P 500 ETF (VOO), is down more than 2.5%.
If the economy weakens and the Federal Reserve lowers interest rates, both long-term and intermediate-term ETFs will likely have nice gains. In a report last week, Bank of America Securities economists wrote that they expect the Fed to guide rates lower in September, “once the initial bounce from reopening subsides and it becomes apparent that the economy is in for a slow and bumpy recovery.” That could make Treasury bonds maturing in five to seven years a sweet spot for investors: Intermediate-term Treasury ETFs, such as the Vanguard Intermediate-Term Treasury ETF (VGIT) or the iShares 3-7 Year Treasury Bond ETF (IEI), could gain value.
Worried about rates rising during a recovery? Stick with shorter-term Treasury funds, such as the iShares 1-3 Year Treasury Bond (SHY). Financial planner Lewis Altfest advises some people to park cash in money-market funds or certificates of deposit for a couple of years—yields are not much lower than Treasuries, and there is little to no risk if rates rise.
Beware the urge to bargain-hunt. There aren’t many bargains out there. Spreads, the difference between yields on investment-grade corporate bonds and Treasuries with the same duration, are just 5% below their highs for the year, notes DoubleLine deputy chief investment officer Jeffrey Sherman. One of the biggest corporate bond ETFs, iShares iBoxx $ Investment Grade Corporate Bond (LQD), plunged 17%, but rebounded sharply and is up 5% year-to-date.
In the March decline, it was possible to pick up high-quality corporate bonds at ultracheap prices, but those opportunities have passed, says Warren Pierson of Baird Funds. There is still “reasonable value in the market,” he says, but fund managers have to hunt for it. Even high-yield bonds have recovered much of their losses. The iShares $ High Yield ETF is only down 2.3% for the year despite a loss of 21.5% just a few months ago.
Sherman says that with the Fed purchasing ETFs that invest in both high-yield and investment grade bonds, investors have begun feeling inappropriately safe: “The Fed is not guaranteeing default positions.”
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>>> Muni Bonds Set for Best Month Since 2009, Shaking Off Fiscal Hit
Bloomberg
By Fola Akinnibi
May 22, 2020
https://www.bloomberg.com/news/articles/2020-05-22/muni-bonds-set-for-best-month-since-2009-shaking-off-fiscal-hit
Tax-free debt heads for 2.7% gain in May, erasing 2020’s loss
Fed intervention, rebound sends cash flooding back in
Municipal bonds are set for their biggest monthly gain since 2009, underscoring the disconnect between the $3.9 trillion market and the economic collapse that’s driving states and cities toward what may be the worst fiscal crisis in decades.
The securities have returned 2.7% so far in May, according to the Bloomberg Barclays index. The rally wiped out the record-setting loss that hammered investors in March and is driving yields back toward the lowest in more than 60 years, with those on benchmark 10-year tax-exempt debt sliding 5 basis points Friday to 0.83%.
The advance has been spurred by an influx of cash into even the riskiest municipal bond funds since the Federal Reserve moved to backstop the market to prevent another liquidity crisis.
Patrick Luby, a municipal-bond analyst with CreditSights Inc., said that investor sentiment has grown less negative as much of the country slowly reopens from the coronavirus shutdowns. At the same time, he said, states and cities are expected to take the steps needed to balance budgets battered by the drop in tax collections.
“The serious and thoughtful way in which many issuers are beginning to wrestle with what are going to be really painful decisions from a financial and human perspective is constructive to the market,” Luby said.
Despite grim news, muni bonds rally back into yearly gain
The market has been whipsawed by unprecedented volatility over the last two months as investors sought to gauge how the shutdown will affect the finances of the thousands of governments and businesses that stand behind municipal bonds. That includes public transit agencies, airports, hospitals and colleges, among others that have been deeply affected by the closing of much of the economy.
With unemployment surging and retail businesses closed, states and cities are predicting hundreds of billions of dollars in budget shortfalls over the next few years. While House Democrats have proposed extending them some $1 trillion in aid, whether any such help will be approved by the Republican-controlled Senate is uncertain.
Even so, the bonds backed by states and cities are among the least likely to default, since governments have the ability to raise taxes and bond payments make up a relatively small share of their budgets.
No state has defaulted since the Great Depression and just a few local governments went bankrupt during the last recession. Since 1970, only about $72 billion of the municipal bonds rated by Moody’s Investors Service defaulted, with about $66.5 billion of that from the bankrupted governments of Detroit, Jefferson County, Alabama, and Puerto Rico, according to a December report from investment firm VanEck.
Still, the muncipal market is dominated by individual investors, who tend to become skittish and withdraw their money when bad news piles up, a phenomenon that analysts refer to as “headline risk.”
“Prices move up or down with greater velocity when you’ve got less liquidity,” said Luby. “There’s still a an enormous amount of uncertainty in the market.”
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>>> Vanguard’s $50 Billion Woman Found Winners in Bond-Market Chaos
Bloomberg
By Liz McCormick
May 20, 2020
https://www.bloomberg.com/news/articles/2020-05-20/vanguard-s-50-billion-woman-found-winners-in-bond-market-chaos?srnd=premium
Wright-Casparius has several funds outperforming most peers
Industry veteran is one of 27 women heading bond funds, ETFs
Vanguard's Wright-Casparius Found Opportunities in Less-Traded Treasuries
Vanguard's Wright-Casparius Found Opportunities in Less-Traded Treasuries
One of the worst-ever bouts of dislocation in the U.S. bond market generated some winning trades for Vanguard Group’s Inc.’s Gemma Wright-Casparius.
As liquidity disappeared amid the pandemic-sparked mayhem in March, the veteran fixed-income portfolio manager saw opportunities, including in older, less-traded Treasuries. The market for these securities had all but vanished after a popular trade that exploits price differences between cash Treasuries and futures blew up.
For Wright-Casparius, the sole head of four actively managed mutual funds with combined assets of about $50 billion, the undervalued securities presented a bargain. As she and a handful of senior colleagues continued to work on the firm’s trading desk in Malvern, Pennsylvania, Wright-Casparius also deemed that inflation expectations had become too dire and increased mortgage-debt holdings. Things soon got so desperate for the bond market that the Federal Reserve stepped in to support it.
Her wagers have paid off, with several of her funds beating most of their peers in 2020. Now, the portfolio manager, who’s been in finance for about 40 years, envisions a long road to economic revival as the nation endures the steepest levels of joblessness since the Great Depression.
“The market gave you some lemons early in March, and we tried to capitalize on that,” Wright-Casparius said in an interview. Going forward, “there’s still a lot of unanswered questions, especially regarding consumer behavior, so the economic recovery should be slow and gradual.”
The $7.2 billion Vanguard Intermediate-Term Treasury Fund, among the four she runs on her own, has returned 7.2% this year -- beating 89% of its peers, according to data compiled by Bloomberg. Her $9.2 billion Short-Term Treasury Fund is outpacing 90% of rivals.
It is part of a select universe of just 31 U.S. fixed-income mutual funds and exchange-traded funds tracked by Morningstar Inc. that were run exclusively by women as of May 1. That tally, helmed by 27 women, is out of more than 2,500 fixed-income funds, with over 2,200 managers, followed by Morningstar. For taxable funds alone, the list shrinks to 16 women.
For women in asset management, progress has been slow, despite widespread focus on the importance of diversity. Even passive funds, a booming area of money management that was once a hot-spot for female talent, have seen the percentage of women managers drop over the past decade.
Women Fail to Gain Ground in Funds World Despite Diversity Push
Still, Wright-Casparius is positive on the prospects for women and is as excited about what she does as when she began her career. Before switching over to asset management, she worked at investment banks including Barclays Plc, where she was director of fixed-income research. She joined Vanguard in 2011.
The two largest holdings in Wright-Casparius’s Intermediate-Term fund as of March 31 were a 0.63% coupon inflation-linked Treasury and a 2.88% coupon regular Treasury, both of which were originally issued in 2018 and mature in 2023, data compiled by Bloomberg show. The fund purchased the former last quarter and added to the latter position during the period, according to the data.
Older securities -- known as off-the-runs -- are tougher to trade even under normal conditions, and were hit hardest by the evaporation of liquidity in March. A blow-up of basis trades -- which exploit price differences between cash Treasuries and futures -- helped stoke the turmoil. That left some off-the-run prices too depressed relative to benchmarks, according to the Vanguard team.
“The volatility in March was breathtaking,” she said. “While part of my management is taking a very long term view, we had dislocations in the Treasury market space and we took advantage.”
‘Accommodative for Years’
The world’s biggest economy will merely hobble back as states and businesses gradually reopen, requiring years of monetary support, in the estimate of Wright-Casparius and her colleagues at the $5.3 trillion asset manager.
U.S. Economy Adds to Grim Records, Signaling Yearslong Recovery
They see the benchmark 10-year Treasury yield bumping around in a range and slowly gliding higher to about 1%, from around 0.7% now. But that level will only be attained by late-2021, when growth finally returns to pre-virus levels and inflation rebounds above the Fed’s 2% target, Wright-Casparius says. Increased government borrowing will help boost long-term yields, said the Queens, New York, native.
The move toward a steeper yield curve -- the gap between 2- and 10-year rates has expanded to about 50 basis points from just above 30 at the start of the year -- will gradually gain momentum, she adds.
“Initially, we see the curve and rates range-bound -- and then toward the recovery phase we are looking for slightly higher yields and slightly steeper curve,” she said.
Vanguard’s downbeat view toward the U.S. growth trajectory is shared by several market veterans and Fed officials. Fed Chairman Jerome Powell says the economy faces unprecedented downside risks that could do lasting damage to households and businesses. The recovery process could stretch through until the end of next year and depend on the delivery of a vaccine, according to Powell.
The central bank has cut rates to near zero and ramped up Treasury purchases to calm markets. It’s also been buying debt in other asset classes, ballooning its balance sheet by more than $2.5 trillion this year.
“The Fed will be accommodative for years,” Wright-Casparius said.
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>>> When United Pawned Old Jets, Bond Traders Sent a Stark Warning
Bloomberg
By Sally Bakewell
May 8, 2020
https://www.bloomberg.com/news/articles/2020-05-09/when-united-pawned-old-jets-bond-traders-sent-a-stark-warning?srnd=premium
Airline pulls $2.25 billion of junk bonds backed by planes
Firms are pledging collateral in bid to raise cash on shutdown
Late on Friday, after some 48 hours of frantic attempts to lure investors to their faltering bond sale, executives at United Airlines let it be known that the deal was dead.
It was an odd moment, stuck smack in the middle of one of the busiest corporate bond booms ever, a period in which investors have shown themselves to be receptive to almost any debt offer backed by good collateral. But this last part was where United got in trouble. For collateral, it had scraped together 360 old jets, some of which analysts considered would be nearly worthless in a few years.
In balking at the deal, investors sent a clear message to CFOs across the country: Don’t try to pawn second-tier assets. Bring us the crown jewels because, regardless of how much Washington policymakers are helping corporate America weather the economic shutdown, the risk of default remains high for all but the most financially solid companies.
“All collateral is not created equal,” said John McClain, a money manager at Diamond Hill Capital Management.
United Air Scraps $2.25 Billion Bond Deal After Terms Disappoint
United Airlines’ attempt to raise $2.25 billion of bonds follows efforts by other virus-stricken companies to mortgage anything they can get their hands on to persuade debt investors to lend them money. In a bid to replace revenue wiped out by the virus pandemic, they’ve pledged private islands in the Caribbean and the Bahamas, cruise ships, movie theaters and even spare engines.
Collateral has been an important safeguard for investors, who have bought billions of dollars of debt from struggling companies in recent weeks. They can seize it if a borrower falters and can’t pay them back in cash. But the United deal shows investors have their limits in who they’ll lend to.
“The collateral issues were too difficult to overcome,” Roger King, an analyst at debt research firm CreditSights, said of the United deal. Borrowers “keep throwing stuff overboard, hoping they can reach the port before there’s nothing left,” he said, likening it to the book “Around the World in 80 Days.”
Companies have been furiously tapping the bond market to shore up liquidity, following unprecedented action by the Federal Reserve last month pledging to buy certain debt. The companies are in dire enough shape that the secured-debt deals are essentially “quasi-rescue trades,” said Ben Burton, head of U.S. leveraged finance syndicate at Barclays Plc.
Gimme Shelter
Sales of secured U.S. high-yield bonds have tripled this year
There’s nothing unusual about struggling borrowers posting swathes of assets against their borrowings. Ford Motor Co. had to mortgage virtually everything it had in 2006 to avoid bankruptcy, arranging some $23.4 billion of debt by putting up all major assets including its blue oval logo. It’s also not unusual for borrowers and lenders to joust over the value of the collateral and whether it’s even accessible to claim.
But in the current depressed environment, even seemingly highly prized collateral is leaving some investors cold. Demand for United Airline’s bonds, for which unofficial price discussions rose to a yield of about 11%, had been weak over the concerns that its collateral wasn’t valuable enough to compensate for the risks.
The aircraft had an average life of 19 years, making them less efficient and more of a liability, according to CreditSights’ King. They’re also about five years from retirement, meaning they could be out of operation and “worth little more than the engines” before a portion of debt matures. That could render investors undersecured, he said.
Vince Pisano, a senior analyst at Xtract Research, said the $4.3 billion appraised value of the aircraft also raised a few eyebrows for him.
If the company went under, he said, “who is going to want to or be able to pay that amount? Think a private equity firm is going to want to start a new airline and pay those prices?”
Before pulling the deal on Friday, United had sweetened terms in a bid to attract investors. It also added a clause that would trigger repayment of the bonds at a substantial premium to par, known as a make-whole, should the company file for bankruptcy. And while the pulled deal dims the company’s funding prospects, it still has a $2 billion one-year loan giving it some breathing room. It had about $9.6 billion of liquidity as of April 29.
Companies in the entertainment business are also putting up their core holdings to induce investors. Theme park company Six Flags Entertainment Corp. sold $725 million of secured bonds in April, pledging its theme parks and water parks.
AMC Entertainment Holdings Inc. sold $500 million of bonds last month and backed them with collateral including movie theaters, according to a person familiar with the matter. That bond has since sunk to about 80 cents on the dollar, according to Trace pricing. AMC’s prospects have looked bleak, forced like its rivals to close cinemas and furlough workers. For weeks, the company faced pronouncements from analysts and trade publications that it’s on the brink of bankruptcy.
Norwegian Cruise Line Holdings Ltd. put up its Great Stirrup Cay island in The Bahamas and Harvest Caye island off the coast of Belize to help sell $675 million of debt, according to a person familiar with the matter. The real estate was appraised with a market value of $260 million, though Norwegian said the investment value should be nearly three times that, based on the destinations’ importance for its cruise operations and future cash-flow.
Even with a hefty 12.575% yield, investors were taking a risk. Norwegian Cruise had indicated it may not survive the disruption and, like rival operators, has suspended operations through June 30. Many analysts fear the cruise industry will take longer to recover, if at all, tarred by virus outbreaks on ships at sea. Norwegian is offering a three-day Bahamas round-trip cruise from Miami from $149.
Norwegian said the bond sale and other transactions alleviate worries about its ability to continue as a going concern for the next 12 months.
Last month, another cruise operator, Carnival Corp., sold $4 billion in bonds backed by 86 of its cruise ships and intellectual property valued at almost $29 billion, according to documents seen by Bloomberg News. It was unclear if any of the ships that had outbreaks of the virus were included in the 86 vessels.
Delta Air Lines Inc. raised $5 billion of bonds and loans backed by slots at some of the world’s busiest airports, as well as flight routes in Europe and Latin America. While they are valuable to airline business and don’t depreciate over time, King argues that there are questions over their true ownership, meaning investors might not be able to benefit from this collateral come crunch-time.
While these assets can provide liquidity for companies, “investors must be discerning and understand their ability to take possession and resell in the event of default,” said Diamond Hill’s McClain.
Now that companies have put a lot of their assets up as collateral, many of them may face big hurdles if they go back for another round of financing.
“The degree to which companies will be able to hold back on unencumbered assets for double dips later depends on how stressed of a situation it is,” Barclays’s Burton said. “If they have to come back, some will be able to, but others will have to find other sources of capital if they need more money.”
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>>> Wave of U.S. Bankruptcies Builds Toward Worst Run in Many Years
Bloomberg
By Eliza Ronalds-Hannon, Katherine Doherty, and Davide Scigliuzzo
May 7, 2020
https://www.bloomberg.com/news/articles/2020-05-07/wave-of-bankruptcies-builds-as-debt-and-virus-clobber-companies?srnd=premium
Neiman Marcus’s Thursday filing is one of many expected
Companies have pre-existing debt made unmanageable by lockdown
First, J. Crew. Now Neiman Marcus. Flashing red: J.C. Penney, Hertz and many more.
Get ready for what could be the most jarring stretch of corporate bankruptcies in memory. The coronavirus has crushed the life out of some venerable household names.
For many troubled companies, like luxury retailer Neiman Marcus Group Inc., which filed on Thursday, the lockdown super-charged the effects of pre-existing problems like debt overloads and the inability to please fickle consumers. For others, the debt they rack up while the pandemic rages may prove insurmountable once the health threat is over.
Few industries have been spared.
“Everyone’s distressed watch list has become so big that it doesn’t even make sense to call it a watch list -- it’s everyone,” said Derek Pitts, head of debt advisory and restructuring at PJ Solomon, which tracks the financial well-being of hundreds of companies using a color code. “You turn page after page and it’s all red. It’s a sea of red.”
The numbers look nauseating and will probably get worse before they improve. Here’s a sampling: The amount of debt classified as distressed in the U.S. surged 161% in just the last two months to more than half a trillion dollars. In April, corporate borrowers defaulted on $35.7 billion of bonds and loans, the fifth-largest monthly volume on record, according JPMorgan Chase & Co. And so far in 2020, the pace of corporate bankruptcy filings in the U.S. has already surpassed every year since 2009, the aftermath of the global financial crisis, Bloomberg data show.
Even the bankruptcy process has been complicated by the virus, with social distancing making it impossible for companies to conduct asset sales that may keep them in operation and save jobs.
Pandemic Pain
Distressed debt has surged in sectors hit hard by the economic shutdown
Note: Energy includes oil and gas-related sectors, pipelines, coal, electric and alternative energy.
And though Washington is tossing out life preservers to select industries -- a total of $19.4 billion in federal aid has been doled out to the four biggest U.S. airlines -- the flood of filings is expected to continue.
Larry Fink, BlackRock Inc.’s chief executive officer, said this week on a private call with investors that he wondered if the Federal Reserve needed to do more to stem a bankruptcy cascade.
Just Beginning
“The wild ride of Covid-triggered restructurings is really just beginning,” said Mo Meghji, founder and CEO of restructuring adviser M-III Partners.
The wave of post-virus bankruptcies kicked off April 1 with shale driller Whiting Petroleum Corp. Plummeting demand for oil and a Saudi-Russian price war nudged the company onto the ledge. Crude prices hovering around $20 a barrel pushed it off. The company didn’t immediately respond to requests for comment.
Frontier Communications Corp. was one of the biggest telecom reorganizations since Worldcom Inc. in 2002. A combination of $17.5 billion in debt and a bet that customers would keep using land lines led to its April 15 filing.
Cases Accelerated
“So far, the vast majority of bankruptcy cases we’ve seen are cases that would’ve come anyway,” said Bruce Mendelsohn, partner and head of the restructuring group at investment bank Perella Weinberg Partners. “Maybe they’ve been accelerated as a result of the Covid-19 environment, but I think we would’ve expected them to occur irrespective.”
Fast Clip
U.S. corporate bankruptcies are on pace to approach 2009 level
Note: Chapter 11 and 7 filings for public and private firms with liabilities > than $50 million
J. Crew Group Inc. and Neiman Marcus were fat with debt from leveraged buyouts when the pandemic hit.
J. Crew had been acquired in 2011 by TPG and Leonard Green & Partners. The private equity firms’ stake will be wiped out through a debt-for-equity swap in the bankruptcy, filed May 4.
The future of its 181 J. Crew stores worldwide, its 140 Madewell stores and its 170 factory stores, along with 13,000 employees, is up in the air. About 11,000 have already been furloughed during the shutdown. The company said it’s “hopeful that jobs will be minimally impacted when stores reopen.”
Neiman Marcus
Neiman Marcus, sold in 2013 to Ares Management Corp. and the Canada Pension Plan Investment Board, tried to spend more to lure customers while taming its debt. Success was mixed. When it filed Thursday, the chain was close to a deal to hand over control of the company to creditors led by bond shop Pacific Investment Management Co.
Read more: Neiman Marcus Goes Bankrupt, Idled by Virus, Crushed by Debt
For Gold’s Gym, 2019 was the strongest year for worldwide growth in its 55-year history, the company said. Then came Covid-19.
“This has been a complete and total disruption of every one of our business norms, so we needed to take quick, decisive actions to enable us to get back on track,” the company said in an online statement that accompanied its May 4 bankruptcy filing.
Gold’s Gym said it will complete its pre-negotiated Chapter 11 process by August. Though it permanently closed 30 locations, about 700 will be ready to open as stay-at-home rules are relaxed, it said.
“We’re absolutely not going anywhere,” the company said on its website.
Men’s fashion brand John Varvatos Enterprises Inc., makers of a $3,000 shearling coat (on sale), filed for bankruptcy Wednesday. It said in its first-day declaration that its decline began in 2015, but said its business was poised for a comeback when the coronavirus had a “debilitating effect.”
Used Cars
Two-thirds of Hertz Global Holdings Inc.’s revenue comes from business at airports. With terminals looking post apocalyptic, the car-rental company is vulnerable.
To make matters worse, used-car prices fell 12% in the first half of April compared with March. If that trend continues, it could further injure Hertz, which uses sales of its existing fleet to fund its newer cars.
A Hertz Global Holding Inc. Rental Location Ahead As Earnings Released
An American Airlines plane flies above the Hertz car-rental location at LaGuardia Airport in New York.Photographer: Victor J. Blue/Bloomberg
The 118-year-old J.C. Penney Co. has nearly 850 stores that have all gone dark with no set date for reopening. The company skipped an interest payment April 15 and is preparing to file for bankruptcy in the absence of a rescue.
“Many companies aren’t paying rent or vendors either right now, so they’re just accumulating liabilities to deal with later,” said Perry Mandarino, head of restructuring and co-head of investment banking at B. Riley FBR Inc.
As the coronavirus continues to spread, a new wave of debt has come up for sale.
Cruise operator Carnival Corp. sold $4 billion in bonds in April and the major U.S. airlines combined have issued at least $5 billion so far.
Carnival attached to its issuance a coupon of 11.5%, one of the highest ever offered by a company with an investment-grade rating. The company didn’t immediately respond to requests for comment.
The borrowers may be setting themselves up for future failure, said Meghji of M-III Partners.
“There’s a large universe of companies that have been massively affected by Covid-19 and it’s unclear whether the slope of recovery will be fast enough for them to avoid bankruptcy,” Meghji said. “The debt they are taking on now will put that much more pressure on their finances going forward.”
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Those sound about right. So for most active investors that means directly owning only A and better stuff and holding a lot of lower quality stuff via junk bond funds if one's up for some risk. With tax rates so low nowadays, there's not much case for many people to have munis, other than for diversification. They do have a strong track record going back to the Great Depression and long before that.
Most people should stick with short maturities but that's mostly about inflation risk. I'll go out about 10-15 years but laddered with shorter stuff such as MM funds and bank CDs.
I've only ever had one bond default, a muni revenue bond, but it was insured.
Bar, With individual bonds, the number of different issuers you'll need in order to manage the risk of default is as follows (a general rule of thumb) -
AAA-US Treasuries - 1
AAA-AA Munis - 5-7
AAA-AA Corporates - 15-20
A Corporates - 30-40
BBB - 60+
Excellent post and good talking points. When you buy a short term high yield bond you certainly don't want it called quickly, although that occasionally happens to everyone. I'm sure a lot of newbie bond buyers make that mistake. Most investors really should stick to professionally managed low expense funds for bonds.
BTW, I did ask my broker about call features on those bonds and he said there were none.
And like I've often said, low/free commissions are among the worst things to happen to the average stock newbie.
Bar, Brokers like the muni side (compared to corporates) because a lot of munis have call features (corporates rarely do), and when they get called you'll have to reinvest the money into something else, which generates another commission.
The best way to get individual bonds from a broker is as a new issue, if the brokerage is one of the underwriters for the offering. Then there's no commission, although the brokerage still profits indirectly.
Buying through a full service broker is the biggest ripoff going, but people still do it. One good thing is you won't be tempted to sell or trade, due to all the commissions. But that can be a disadvantage if a bond runs into real trouble, since you'll tend to hang on too long.
My dad has a Ford bond which has been downgraded (in stages) into the junk range. I thought about selling it last year, but now we're stuck with it. The bond has a 7.45% coupon, which is great, but the price of the bond got whacked big time upon the downgrade. The $20 K bond was worth $24 K last year, but with the downgrade it's value dropped to $15 K. Hopefully Ford won't default in the next 11 years, but these are the problems we face when owning individual bonds.
Last month, I did something I shouldn't have done. One of my "starving" brokers, who I almost never hear from, phoned to offer me some small quantities of several muni bonds from my state.
Generally, I stick with the large multi-state bond funds from Vanguard. For one thing, my income isn't that high anymore. Plus yield on munis vary wildly by state for a number of reasons... mostly due to quality. Tax exempt bonds from my state pay little more than taxable debt.
In any event, he sold me slivers of four or five issues, all rated AA- and above, with short maturities under about 6 years. For me, liquidity isn't an issue because I'll hold everything to maturity. My Dad invested like that. He had oddball amounts of most issues... $17,000, $39,000 etc. Selling them would have been very costly, but he never sold anything and never suffered a default.
But as a general rule, when a broker offers you something, you don't want it. That's especially true these days, and with munis where the market is so opaque. That broker who had worked with my Dad, and later my Mom, has always been reputable but still he's a Stock Broker!!! I should have made notes, thought it over and called him back an hour later with a well-reasoned decision. But I bought everything without hanging up the phone. Still, I think that's worked out due to a pretty solid muni bond market.
Bar, >> muni and corp bond funds <<
They likely did fall in mid March, but only briefly and then quickly rebounded once the Fed stepped in with liquidity. VTEB and VTC are good surrogates for the overall muni and corp bond sectors, but if you blinked you would have missed the crash that occurred in mid March. On the charts you can see the temporary collapse, and it was scary to watch, the bond markets were seizing up until the Fed arrived. Munis and corporates dropped 20% and 27% respectively, but then came right back.
One problem with bonds now is that with the Fed returning to ZIRP, there is little chance for any additional capital gains, all you'll get now is the coupon rate. I was enjoying that gradual decline in interest rates, which had bond prices in a nice steady uptrend. That part is gone now, but if you have bonds from years ago you'll still get the high coupon rate.
I follow the bond market fairly closely since my dad has a 36% allocation to bonds. He has a lot of individual corporates from years ago with coupon rates from 5.1-7.45%, and munis from 3.35-4.6%. In comparison, muni rates now are running 2.22% (VTEB), and corporates 3.27% (VTC), so these older bonds have a big premium.
None of my muni and corp bond funds have fallen due to CV.
Fed intervention? I don't know. All of my fixed income holdings are blue chipish. No high yield junk.
Fed buying junk bond ETFs -
This will help keep the CLO-leveraged loan market from blowing up. They are mainly targeting companies whose bonds were recently downgraded from the lowest investment grade (BBB-) to the higher levels of junk (BB+ to BB-). But they are apparently also buying junk bond ETFs like HYG and JNK, which hold bonds rated below BB-.
For example, looking at HYG (i-Shares) - 33% of its holdings are single B rated (B), and 10% are CCC. So if the Fed is stepping in to buy this ETF, they are providing support for the junkier junk bonds too. The SPDR ETF (JNK) also has 35% in single B rated bonds, and 13% in CCC or under.
Fed to buy junk bonds - >>> These stocks may bounce as the Federal Reserve buys junk bond ETFs, according to Jefferies
Bloomberg
April 13, 2020
By Philip van Doorn
https://www.marketwatch.com/story/these-stocks-may-bounce-as-the-federal-reserve-buys-junk-bond-etfs-according-to-jefferies-2020-04-13?siteid=yhoof2&yptr=yahoo
The Federal Reserve’s unprecedented bond purchases will take a load off leveraged companies
XPO Logistics is on a list of leveraged companies rated “buy” by analysts at Jefferies. XPO Logistics
The Federal Reserve is now buying junk bonds, and analysts at Jefferies argue that presents an opportunity for investors to load up on shares of leveraged companies that are out of favor.
The Fed expanded its Secondary Market Corporate Credit Facility on April 9. The Federal Reserve Bank of New York, the largest of the Fed’s 12 district banks, will buy up to $750 billion in corporate bonds. Most of the purchased bonds will have investment-grade ratings of at least BBB-/Baa3 (minimum investment grade ratings of Standard & Poor’s and Moody’s, respectively).
But the central bank made a big splash by saying the New York Fed will also purchase bonds recently downgraded from investment grade ratings as of March 22 or later that are now rated at least BB-/Ba3. More importantly, the Fed said it will purchase shares of exchange traded funds “whose primary investment objective is exposure to U.S. high-yield corporate bonds.”
You can read the Fed’s entire description of the corporate buying program here.
https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200409a2.pdf?mod=article_inline
This is a “game changer,” according to Jefferies equity strategist Steven DeSanctis, “as stocks that have leverage were being treated as if they were going out of business and were hammered regardless of how well or poorly their forward prospects looked.”
In a note to clients on April 12, DeSanctis and analysts at Jefferies listed 18 stocks they believe “were beaten up but have the wherewithal to make it to the other side” of the coronavirus recession.
Investors already reacted to the Fed’s announcement by sending the iShares iBoxx $ High Yield Corporate Bond ETF HYG, up 6.5% to close at $82.36 on April 9. (The stock market was closed on Good Friday, April 10.)
HYG pays a monthly dividend and has a yield of 5.31%, which compares to a yield of 3.14% for the iShares i Boxx $ Investment Grade Corporate Bond ETF LQD, and 2.04% for the Vanguard Intermediate-Term Treasury ETF VGIT.
Highly leveraged companies rated ‘buy’
DeSanctis and equity analysts at Jefferies listed 18 “levered names that could be misunderstood by the market” that are also rated “buy” by the firm, in a note to clients on April 12. Here they are, with 2020 performance and debt-to-equity ratios, according to FactSet:
COMPANY TICKER LONG-TERM DEBT/ EQUITY TOTAL RETURN - 2020 THROUGH APRIL 9 DIVIDEND YIELD - CURRENT INDUSTRY
Acadia Healthcare Company Inc. ACHC, -5.08% 58.5% -31% 0.00% Medical/Nursing Services
Aptiv PLC APTV, -2.39% 50.0% -34% 1.41% Auto Parts: OEM
Berry Global Group Inc BERY, -2.69% 85.4% -21% 0.00% Containers/Packaging
Capri Holdings Ltd. CPRI, -2.61% 41.2% -65% 0.00% Apparel/Footwear Retail
Federal Realty Investment Trust FRT, -2.81% 56.9% -33% 4.88% Real Estate Investment Trusts
Floor & Decor Holdings Inc. Class A FND, -4.16% 54.1% -28% 0.00% Home Improvement Chains
Foot Locker Inc. FL, -7.64% 48.4% -35% 6.40% Apparel/Footwear Retail
Freeport-McMoRan Inc. FCX, +1.34% 51.7% -37% 0.00% Other Metals/Minerals
Hologic Inc. HOLX, -0.36% 52.6% -21% 0.00% Medical Specialties
LyondellBasell Industries NV LYB, -1.51% 59.4% -37% 7.13% Chemicals: Specialty
ON Semiconductor Corp. ON, +3.49% 42.2% -44% 0.00% Semiconductors
Parker-Hannifin Corp. PH, -4.31% 50.9% -29% 2.42% Industrial Machinery
Sealed Air Corp. SEE, -4.31% 101.5% -22% 2.08% Containers/Packaging
Sysco Corp. SYY, -5.12% 71.6% -41% 3.63% Food Distributors
Williams Companies Inc. WMB, +3.07% 56.7% -28% 9.64% Oil & Gas Pipelines
Wyndham Destinations Inc. WYND, -0.82% 104.5% -55% 8.66% Timeshares
Wyndham Hotels & Resorts Inc. WH, -6.58% 63.0% -45% 3.73% Hotels/Resorts/Cruiselines
XPO Logistics Inc. XPO, -6.62% 67.9% -22% 0.00% Trucking
Source: FactSet
You can click on the tickers for more about each company.
You will have to scroll the table to see all the data, including dividend yields and industry groups.
If you see any stocks of interest here, you had better do your own analysis to form an opinion of a company’s ability to remain competitive for the next decade, while also considering the viability of its industry group, before making a long-term commitment
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>>> Supercharged Debt Bets Unravel and Expose Wall Street Risks
Bloomberg
By Sally Bakewell, Sridhar Natarajan, and Nabila Ahmed
April 1, 2020
https://www.bloomberg.com/news/articles/2020-04-01/supercharged-debt-bets-unravel-and-expose-wall-street-s-big-risk?srnd=premium
Low rates spurred bond sales to buyers eager to juice returns
‘You have junkier and junkier debt, and it’s super levered up’
For years, regulators have tried to make the financial system safer by blocking banks from taking on the extreme leverage that almost toppled the industry in 2008. Turns out, the risks just moved.
In a matter of days, a slew of trades unraveled to expose various forms of soured levered bets at their heart. Michael Hintze’s flagship hedge fund scrambled to contain losses on a structured credit trade gone awry. Banks including Citigroup Inc. tried to sell $1.3 billion of risky loans to unwind clients’ leveraged wagers. Funds that borrow to load up on mortgage bonds fed a flood of liquidations. A similar situation played out at municipal-bond funds.
In 2008, the culprits were real estate speculators, investments banks that fueled the bubble while leveraging books about 40 to 1, and investors who failed to conduct their own due diligence. A wave of defaults caused that system to come crashing down.
This time, another long period of rock-bottom interest rates, most recently cheered on by President Donald Trump, has let companies go into record debt while showering cash on shareholders. The enablers are banks eager to facilitate deals and investors desperate for higher returns. They borrowed to multiply profits on mortgages, junk debt and municipal and government bonds. The leverage means losses are getting amplified too.
“Everyone knows you are playing with fire with leverage,” said Michael Terwilliger, a portfolio manager at Resource Credit Income Fund. “Response to the last panic has built the new panic.”
After years of relatively sedate markets, trades are suddenly getting tested by the Covid-19 pandemic. Emergency measures to contain the virus’s spread are slamming the brakes on commerce, shutting businesses and leaving millions of Americans jobless. The economic downturn is raising the prospect that consumers and companies will fall behind, defaulting on loans.
A slump in prices for risky debt is putting pressure on investors to pony up collateral or unwind leveraged trades. That feeds a vicious cycle, with rapid liquidations depressing prices further, potentially triggering more margin calls and sales. It’s contributed to violent drops in the market.
Still, there’s scant evidence to suggest the amount of leverage in the system now is as great as it was heading into 2008.
This Is the Greatest Dislocation in Credit Since 2008: Bruce Richards
WATCH: This is the greatest dislocation in credit since 2008, says Bruce Richards, Marathon Asset Management’s chairman and chief executive officer.Source: Bloomberg)
There are few if any public disclosures outlining the magnitude and structures of many leveraged trades. Market insiders and people with knowledge of transactions that unraveled agreed to describe what they have seen on the condition of anonymity.
Swaps
Citigroup and Truist Financial Corp. had to sell off hundreds of millions of dollars in risky credit known as leveraged loans, after prices on the debt collapsed to 10-year lows. The loans were behind total-return swaps, a type of derivative that gives investors amplified exposure to a debt’s performance.
In a typical arrangement, the client pays the bank an agreed-upon rate and in return receives payments based on the performance of the asset without actually owning it. The swaps have mark-to-market triggers that enable banks to demand more collateral if prices fall below a certain level. Depending on how the deal is set up, the assets may be sold.
The sudden plunge in loan prices in March spooked banks. One multibillion-dollar hedge fund manager said the bank he uses put a hard stop on any more such trades because of worries about counterparty exposure in a volatile market.
Hintze, the founder of hedge fund CQS, saw bets in its $3 billion Directional Opportunities fund dive in a matter of weeks. One of the strategies at the fund, which is personally managed by Hintze, sells short-dated protection with credit-default swaps to investment banks on hundreds of investment-grade and high-yield bonds.
Generally, such trades work like so: The initial outlay for an investment fund is a mere fraction of the total outstanding notional value of the bonds being insured, resulting in implied leverage. If the bonds don’t default by the time the protection expires, the firm providing insurance comes out on top. But such bets can be undone by a relatively small number of defaults on the underlying debts.
CLOs
The drop in prices for leveraged loans is also hitting investment vehicles known as collateralized loan obligations that are packed full of them. The vehicles sell an equity slice and interest-paying bonds so they can buy up loans. But to get the deals off the ground, managers kick-start them with borrowing, typically drawing on a form of bank financing known as warehouse facilities. Goldman Sachs Group Inc. and JPMorgan Chase & Co. recently sent out demands to some managers of the deals to put up more cash against those warehouse lines after loan prices fell.
Within the tranches of securities sold by CLOs, the equity is the riskiest piece because it gets paid out only after the bondholders are paid in full. That essentially makes equity stakes another form of leveraged bet on the performance of the loans.
Some investment funds have levered up their bets on securitized debts with bank financing. They might, for example, put up cash as collateral to gain the ability to spend several times that amount on debt, such as highly rated CLOs. In relatively safe pockets of structured credit like AAA-rated CLO paper, investors might borrow at seven times from banks to fund their trades.
Investors can also put up a high-quality asset to borrow cash through the repurchase agreement market, using it to then buy illiquid but higher-yielding assets. In either case, the borrowing of money can magnify returns. Yet if the assets start to lose value, banks can demand more money up front or force liquidations.
Banks now have much higher capital requirements than in 2008. That makes securitized products more onerous for many dealers to hold as collateral, which encourages banks to make margin calls.
Mortgages
Across mortgage land, there are mounting concerns that a growing number of unemployed consumers may soon fail to make payments.
Mortgage real estate investment trusts rely on borrowed money to build their holdings. That leverage helps drive higher returns than what they would eke out by simply collecting interest coupons from the underlying debt. Counterparties are willing to lend because of the pledged collateral.
New Residential Investment Corp., a real estate investment trust focused on housing, has been selling off a portfolio of debt with a face value of $6 billion at a discount in recent days as it seeks to reduce risks and improve liquidity. The REIT, managed by an affiliate of Fortress Investment Group LLC, has said it sometimes uses leverage in the form of financing from banks and securities sales to enhance returns.
Last week, AG Mortgage Investment Trust Inc. said it had failed to meet some margin calls from financing counterparties and that it didn’t expect to meet future margin calls with its current financing. The firm, which said it planned to talk with financing counterparties, didn’t elaborate on the transactions at issue.
Some, like Cherry Hill Mortgage Investment Corp. have also been dealt a blow on so-called credit-risk transfer trades. Such securities offer higher returns on a pool of residential loans because investors agree to take borrower default risk off the hands of Fannie Mae and Freddie Mac. The lowest-rated slices of that debt have plunged because they’re the first to take a hit if the loans go bad. That contributed to the troubles at Cherry Hill, which elected to pay half its dividend in stock last week, citing market volatility.
Muni Bonds
In the $3.9 trillion municipal-bond market, large municipal-bond funds run by Nuveen, BlackRock Inc., Pacific Investment Management Co. and Invesco Ltd. unwound a leveraged investment strategy that backfired last month when short-term borrowing costs spiked.
The companies liquidated $2.5 billion of tender-option bond trusts, contributing to a flood of debt unloaded during a record-setting selloff. The trusts issue floating-rate notes to money-market funds and use the cash to buy higher-yielding long-term bonds. Mutual funds seek to pocket the difference in yield between the two.
Treasuries
Even swings in prices on the most ironclad securities can catch wrong-footed investors.
Hedge funds got hammered by moves in the Treasury market last month that derailed a popular strategy. The maneuver uses money borrowed from repo markets to exploit differences between cash Treasuries and futures. Some firms had levered up wagers as much as 50 times, people familiar with the situation told Bloomberg. Leveraged funds’ exposure to the so-called basis strategy could be as much as $650 billion, JPMorgan strategists said.
Read more: How leverage burned hedge funds in Treasury market
“There’s been an exogenous shock that’s exposing leverage in the system,” said Michelle Russell-Dowe, head of securitized credit at Schroders. “There will be winners and losers, and it will all ultimately come down to leverage.”
Regulators focused on banks when they set out after the 2008 financial crisis to rein in the excessive risk-taking that threatened to upend the financial system. But as the U.S. emerged from that wreckage, the Fed kept lending rates so low that companies across the country binged on borrowings, with U.S. businesses taking on $16.1 trillion, up from $10.2 trillion a decade ago. Investors lined up to lend, in part because U.S. rates were still higher than those in Europe and Japan.
In their enthusiasm, investors let borrowers strip protections, known as covenants, from risky loan contracts. The leveraged lending market expanded to $2.1 trillion. Sales of CLOs, the biggest buyer of leveraged loans, more than doubled to around $670 billion from 2010. A new borrowing complex known as private credit grew, drawing lending even further away from regulated banks to an $812 billion world of non-regulated lenders operating largely out of the authorities’ gaze. Meanwhile, banks rebuilt their derivatives operations.
The overall result was a growing pile of risky debt and a variety of options to juice profits.
“You have junkier and junkier debt, and it’s super levered up,” said Stephen Blumenthal, chief investment officer at CMG Management Group Inc. “When you get yields compressed to record lows, it takes more leverage to generate return. It’s classic human and end-of-cycle behavior.”
To be sure, a number of elements of the market are safer now. CLOs sold after the financial crisis don’t have mark-to-market triggers forcing investors to sell when prices fall below certain thresholds, meaning there’s a very high hurdle to breach before liquidation is triggered. Most of the bank warehouse credit lines that CLO managers use also aren’t marked to market.
This time, authorities were quick to roll out measures aimed at putting a bottom under asset prices with corporate bond buying programs. And Congress and the Trump administration are about to hand money directly to people and businesses.
“This unprecedented $2 trillion shock-and-awe fiscal stimulus has been conceived in a relatively thoughtful way,” said Stephen Ketchum of Sound Point Capital Management. Banks were the heart of the problem in 2008 and received much of the money directly, which was relatively simplistic. “Now we’re trying to get money to millions of individuals and thousands of businesses that are being affected by Covid-19. It will be a massive undertaking to get it right.”
The coming weeks will be telling. Unlike a decade ago, when regulatory filings gave the public some insight into the types of risk-taking by banks that contributed to the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc., it’s more difficult to see this time how much leverage has accrued, or which investment firms might be most exposed.
The answer will emerge with time, leaving the Fed to face the issues created by its decade of low rates.
“Post-crisis policies drove everyone to places where they shouldn’t have been,” said Larry McDonald, author of the book “A Colossal Failure of Common Sense” about Lehman’s demise. “And then the Black Swan hit.”
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>>> A $33 Billion ETF Sees Most Cash in 18 Years on Fed-Fueled Rally
Bloomberg
By Katherine Greifeld
March 25, 2020
https://www.bloomberg.com/news/articles/2020-03-25/a-33-billion-etf-sees-most-cash-in-18-years-on-fed-fueled-rally?srnd=premium
LQD on track for best week ever after $1.5 billion inflows
Fed signaled ‘unlimited firepower’ for bond markets: Tannuzzo
The Federal Reserve’s planned foray into the corporate-bond market has exchange-traded fund investors rushing in at a breakneck pace.
Investors poured a record $1.5 billion into the iShares iBoxx $ Investment Grade Corporate Bond ETF on Tuesday, following a $1 billion influx on Monday, according to data compiled by Bloomberg. The back-to-back inflows have put the $33 billion LQD on track for its best week on record after the U.S. central bank said it would begin buying corporate bonds and certain credit ETFs.
The Fed’s pledge of support and a $2 trillion stimulus deal have eased corporate default fears after the coronavirus outbreak reignited solvency concerns. Now, investors are racing to get ahead of the central bank’s purchases. LQD has rallied for four consecutive sessions and posted its biggest gain since 2008 on Monday after the Fed announced its plans.
“Signaling that they have unlimited firepower is huge for the market,” said Gene Tannuzzo, a Columbia Threadneedle portfolio manager. “The investment-grade market offers the best risk-adjusted return right now.”
LQD sees biggest inflow ever as high-grade bonds rally
The U.S. central bank said Monday that it would create a Secondary Market Corporate Credit Facility, one of several new measures aimed at cushioning the economic blow from the coronavirus. The terms of the facility allow for the purchase of up to 10% of an issuer’s outstanding bonds and up to 20% of the assets of any ETF “whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds,” a primer accompanying the Fed action said.
The Fed’s involvement is also helping to restore order to credit ETFs, Tannuzzo said. LQD’s share priced has climbed nearly 3% higher than the value of its underlying assets -- the fund’s biggest premium since 2009. Last week, it slumped to a discount of 5% relative to the presumptive value of its bond holdings.
While policy makers have committed to being the “broker of last resort” for U.S. corporations, uncertainty over the virus’ economic fallout will limit the rally in high-grade bonds, according to Janney Montgomery Scott LLC’s Guy LeBas.
“Now that the liquidity floor is in place, that should support valuations to a point, but I doubt spreads return to pre-February levels for some time,” said LeBas, chief fixed income strategist. “Pricing credit is a very imprecise exercise right now given the unprecedented nature of the economic downturn.”
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>>> 12 Bond Mutual Funds and ETFs to Buy for Protection
Kiplinger
By Ellen Chang
March 18, 2020
https://www.kiplinger.com/slideshow/investing/T018-S001-20-dividend-stocks-to-fund-20-years-of-retirement/index.html
As the stock market continues to take a beating, nervous investors look to bond mutual funds and exchange-traded funds (ETFs) for protection and sanity. After all, fixed income typically provides regular cash and lower volatility when markets hit turbulence.
And the markets are absolutely hitting turbulence. For instance, between Feb. 19 and March 10, not only did the S&P 500 experience a historically rapid loss of 14.8% – it experienced a dramatic rise in volatility, too, hitting its highest level on that front since 2011, says Jodie Gunzberg, chief investment strategist at New York-based Graystone Consulting, a Morgan Stanley business. The index's losses and volatility have escalated even more since then.
Bonds offer ballast – "not only downside protection but also moderate upside potential as investors tend to seek out the safety of U.S. government and investment-grade corporate bonds amid stock market uncertainty" – says Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA, a New York-based investment research company.
Bond prices often are uncorrelated to equities. Stocks typically do well in periods of economic growth, whereas bonds typically do well in periods of declining economic activity, Gunzberg says.
"Even though the current 30-day correlation has risen between stocks and bonds, the correlation between the S&P 500 and the S&P U.S. Aggregate Bond Index is still negative," she says. "Bonds are strong diversifiers, with the exception of high yield (junk), when added to a portfolio of equities throughout different economic scenarios." Indeed, junk debt has been punished severely of late.
Here are 12 bond mutual funds and bond ETFs to buy. These funds offer diversified portfolios of hundreds if not thousands of bonds, and most primarily rely on debt such as Treasuries and other investment-grade bonds. Just remember: This is an unprecedented environment, and even the bond market is acting unusually in some areas, so be especially mindful of your own risk tolerance.
Returns and data are as of March 17, unless otherwise noted. For mutual funds, returns and data are gathered for the share class with the lowest required minimum initial investment – typically the Investor share class or A share class. If you use an investment adviser or online brokerage, you may be able to buy lower-cost share classes of some of these funds. Yields are SEC yields, which reflect the interest earned after deducting fund expenses for the most recent 30-day period and are a standard measure for bond and preferred-stock funds.
iShares Core U.S. Aggregate Bond ETF
ASSETS UNDER MANAGEMENT: $71.0 billion
SEC YIELD: 1.8%
EXPENSES: 0.05%
Just like S&P 500 trackers such as the iShares Core S&P 500 ETF (IVV) are how you invest in "the market," the iShares Core U.S. Aggregate Bond ETF (AGG, $110.79) is effectively the way to invest in "the bond market."
AGG is an index fund that tracks the Bloomberg Barclays U.S. Aggregate Bond Index, or the "Agg," which is the standard benchmark for most bond funds. This portfolio of more than 7,600 bonds is heaviest in Treasuries, at a 42% weight, but also has significant exposure to mortgage-backed securities (MBSes, 28%) and corporate debt (24%), as well as sprinklings of agency, sovereign, local authority and other bonds.
This is an extremely high-credit-quality portfolio that has nearly 75% of its assets in AAA debt, the highest rating possible. The rest is invested in other levels of investment-grade bonds. That makes AGG one of the best bond ETFs if you're looking for something simple, cheap and relatively stable compared to stocks.
Vanguard Total Bond Market ETF
ASSETS UNDER MANAGEMENT: $50.7 billion
SEC YIELD: 1.9%
EXPENSES: 0.035%
The Vanguard Total Bond Market ETF (BND, $82.85) is another name in broad-exposure bond funds. It targets U.S. investment-grade bonds and is geared for investors with medium- or long-term goals.
"Total" bond ETFs like BND incorporate a wide spectrum of fixed-income investments in a passively managed vehicle, says Mike Loewengart, managing director of investment strategy at online brokerage firm E*Trade Financial.
"Fixed-income investments can add ballast to your portfolio, especially during wild market swings," he says. "Investors leverage bonds because they are more predictable than equity investments, albeit a bit more boring, which turns off some investors."
BND holds roughly 9,200 bonds, with about 44% of those holdings in Treasury and other agency debt, 27% in investment-grade corporates, 24% in MBSes and the rest sprinkled across bonds such as sovereign debt and asset-backed securities (ABSes). It's also available as a mutual fund (VBTLX).
iShares Core Total USD Bond Market ETF
ASSETS UNDER MANAGEMENT: $4.6 billion
SEC YIELD: 2.1%
EXPENSES: 0.06%, or $6 on a $10,000 investment*
The iShares Core Total USD Bond Market ETF (IUSB, $50.56) is a another strong core bond fund that provides a blend of primarily investment-grade debt, but it also has some exposure to higher-yield bonds that AGG doesn't.
IUSB's portfolio, which includes more than 9,300 bonds, is most heavily weighted in Treasuries, at nearly 36% of the fund's assets. Another quarter of IUSB's assets are invested in investment-grade corporate debt from the likes of AT&T (T) and JPMorgan Chase (JPM), and another quarter is in mortgage-backed securities (MBSes). The rest is sprinkled among agency bonds, international sovereign debt and other types of bonds.
This indexed ETF does have a "slight exposure to high-yield bonds, which tend to do better in a risk-on environment," CFRA's Rosenbluth says. But otherwise, nearly 93% of this bond ETF's holdings are investment-grade, including a 63% slug in AAA-rated bonds.
The yield, at 2%, is about on par with the S&P 500 right now. But IUSB has been far, far less volatile than the blue-chip stock index, losing 4.5% over the past month versus the S&P's 25%.
* Includes a 1-basis-point fee waiver. (A basis point is one one-hundredth of a percent.)
iShares U.S. Treasury Bond ETF
ASSETS UNDER MANAGEMENT: $16.5 billion
SEC YIELD: 0.9%
EXPENSES: 0.15%
If you're looking to focus more on stability than potential for returns or high yield, one place to look is U.S. Treasuries, which are among the highest-rated bonds on the planet and have weathered the downturn beautifully so far.
Bond ETFs like the iShares U.S. Treasury Bond ETF (GOVT, $27.25) give investors direct exposure to U.S. Treasuries. GOVT's holdings range from less than one year to maturity to more than 20 years. Roughly half of the fund is invested in bonds with one to five years left to maturity, another 28% is in bonds with five to 10 years left, and most of the rest is in Treasuries with 20 or more years remaining.
Over the past month, GOVT has actually produced a 3% gain as investors hunker down in safety plays. Just note that an already low yield, as well as little room for yields to go further south, really limit the upside price potential in this bond ETF. But it still might be an ideal place for investors looking for stability and just a little bit of income.
SPDR Bloomberg Barclays 1-3 Month T-Bill ETF
ASSETS UNDER MANAGEMENT: $15.3 billion
SEC YIELD: 1.2%
EXPENSES: 0.136%
This is a tricky time to be buying bonds since "yields are in a race toward zero," says Charles Sizemore, a portfolio manager for Interactive Advisors, an RIA based in Boston.
"Buying longer-term bonds at these prices exposes you to interest-rate risk. If yields bounce off of these historic lows, bond prices will fall," he says. "Given that yields are modest across the bond universe, it makes sense to focus on safety rather than reach for a slightly higher yield that won't really move the needle that much anyway."
In an environment like this, Sizemore believes it makes sense to stay in bonds with shorter-term maturity. The SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL, $91.63) is a liquid way to get access to the short end of the yield curve. It invests in an extremely tight portfolio of just 15 bond issues with thin maturities of between one and three months – good for the truly risk-averse. BIL hardly moves in good markets and in bad. Over the past month, for instance, BIL has gained 0.2%, with a chart that looks like a straight line compared to most major bond and stock market indices alike.
"The yield is a moving target and may approach zero soon due the Federal Reserve slashing rates," Sizemore says. "But you have essentially no interest-rate risk and you're parked in the safest corner of the bond market."
PIMCO Enhanced Short Maturity Active ETF
ASSETS UNDER MANAGEMENT: $13.9 billion
SEC YIELD: 1.9%
EXPENSES: 0.36%
If you prefer to have a human overseeing your short-term bond investments, you can look to actively managed ETFs such as PIMCO Enhanced Short Maturity Active ETF (MINT, $100.10).
Like BIL, MINT is among the more conservative bond ETFs you can buy. The fund currently has more than 840 holdings, with a stated goal of "capital preservation, liquidity and stronger return potential relative to traditional cash investments."
The trade-off? A little bit more risk than, say, a savings account or money-market fund – but far less risk than most other bond funds. The ETF's 840-plus holdings are 93% invested in bonds with less than a year to maturity, with the remaining 7% invested in debt with no more than three years left. More than 75% of the fund's bonds have investment-grade credit ratings – the majority of that is investment-grade corporate debt, though it also includes Treasuries and other bonds.
MINT offers a "relatively attractive yield given its minimal interest-rate risk and can be a stronger alternative to sitting on the sidelines," CFRA's Rosenbluth says.
Vanguard Short-Term Corporate Bond Index Fund ETF
ASSETS UNDER MANAGEMENT: $23.2 billion
SEC YIELD: 1.9%
EXPENSES: 0.05%
Another way to invest in short-term debt is the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH, $76.77).
Given the financial damage happening to even good publicly traded companies, corporate bond funds – even ones that hold investment-grade debt – are hardly bulletproof. Thus, it's worth pointing out that 90% of the bonds in VCSH are in the A or BBB range, the lower of the four investment-grade tiers.
"But given that the holdings are investment grade bonds with only five years or less to maturity, your risk is tolerably low," Sizemore says. Indeed, the average maturity of bonds in the fund is just under three years.
The yield of 1.9% is decent, albeit unspectacular. However, relative stability and an uber-cheap expense ratio make VCSH a decent place to wait out the volatility. If you prefer mutual funds, Vanguard offers an Admiral-class version (VSCSX).
Vanguard Intermediate-Term Bond ETF
ASSETS UNDER MANAGEMENT: $12.7 billion
SEC YIELD: 1.6%
EXPENSES: 0.07%
The Vanguard Intermediate-Term Bond ETF (BIV, $87.25) is an "in the middle fund" that invests exclusively in intermediate-term, investment-grade debt.
It's another index fund, this time investing in bonds with maturities between five and 10 years. More than half the fund is invested in Treasuries and other U.S. government bonds, with another 40% in investment-grade corporates, and most of the rest in foreign sovereigns.
The idea here is to provide more yield than in similarly constructed funds, though at the moment, BIV's yield is actually lower than many shorter-term funds. Year-to-date, however, it's essentially trading flat versus a 1%-plus decline for the "Agg" benchmark. It also has a mutual fund version (VBILX).
Vanguard Long-Term Bond ETF
ASSETS UNDER MANAGEMENT: $5.1 billion
SEC YIELD: 2.6%
EXPENSES: 0.07%
If you do want to roll the dice on longer-term investments for a little more yield, bond ETFs such as the Vanguard Long-Term Bond ETF (BLV, $100.44) can get the job done.
The roughly 2,500-bond portfolio is heaviest in investment-grade corporate debt (48%), followed by Treasury/agency bonds (44%). Almost all of the rest of BLV's assets are used to hold investment-grade international sovereign debt.
The added risk comes in the form of longer maturity. Three-quarters of the fund is invested in bonds maturing in 20 to 30 years, 22% is in the 10-to-20 range, 3% is in bonds with 30-plus years remaining, and the rest is in the five-to-10 range. Because there's more of a chance these bonds won't get paid off than bonds that expire, say, a year from now, that means this fund can rise and fall a lot more than funds like MINT that deal in short-term debt.
But the higher yield might be tempting to some investors.
"With interest rates compressing and the 10-year Treasury at an all-time low, investors might consider adding a long-term bond fund to their portfolio like Vanguard's Long-Term Bond Fund," says Daren Blonski, managing principal of Sonoma Wealth Advisors in California. "Unless you see interest rates rising in the near future, owning a long-term bond fund can provide substantially more income to your portfolio. If interest rates do rise, a long term bond fund would underperform."
Like many other Vanguard bond ETFs, BLV trades as a mutual fund, too (VBLAX).
Vanguard Core Bond Fund Investor
ASSETS UNDER MANAGEMENT: $1.6 billion
SEC YIELD: 2.0%
EXPENSES: 0.25%
Investors looking for an actively managed core bond mutual fund can look to Vanguard Core Bond Fund Investor (VCORX, $10.28).
VCORX invests across the spectrum of investment-grade debt, and it does so across bonds in a wide range of maturities. The portfolio includes slightly more than a thousand bonds at the moment, with an average effective maturity of 7.6 years.
Government mortgage-backed securities are the largest chunk of holdings at 31%, followed by investment-grade corporates (28%) and Treasuries (24%). But it has several other sprinklings of less than 5%, including foreign sovereign bonds, asset-backed securities and short-term reserves.
It’s a young fund that only got its start back in 2016, but so far it’s doing well, with a three-year total return of 13.4% that’s more than two percentage points better than the AGG ETF’s total return. And this actively managed fund is priced like an index fund at 0.25% in annual fees.
DoubleLine Total Return Bond Fund Class N
ASSETS UNDER MANAGEMENT: $55.3 billion
SEC YIELD: 2.99%
EXPENSES: 0.73%
Managed by well-known bond portfolio manager Jeffrey Gundlach, the DoubleLine Total Return Bond Fund Class N (DLTNX, $10.71) acts as a "nice diversifier to core fixed income while providing current income without overstretching in quality for higher yield and strong risk-adjusted returns in varying market and interest-rate environments," says Nicole Tanenbaum, partner and chief investment strategist at Chequers Financial Management, a San Francisco-based financial planning firm.
While DLTNX is a "total return" fund, its primary vehicle is mortgage-backed securities. More than 80% of the bond mutual fund's assets are invested in these right now, with the rest sprinkled among debt such as Treasuries and other asset-backed securities, as well as cash.
"In today's persistent low-yield environment, many investors had been drifting away from safer core bond holdings toward riskier, high-yield credit given the more attractive yields they offer," Tanenbaum says. "While it may be tempting to reach for these higher yields to generate more income, it is critical for investors to fully understand the underlying credit quality of the bonds they are choosing to receive that higher yield."
The retail-class N shares we list here require a $2,000 minimum investment in normal accounts or $500 in an IRA. You can invest in the lower-expense institutional-class shares (DBLTX, 0.48% annual fees) with a $100,000 minimum investment in normal accounts, or a $5,000 minimum investment in an IRA.
BlackRock Strategic Income Opportunities Investor A
ASSETS UNDER MANAGEMENT: $31 billion
SEC YIELD: 2.4%
EXPENSES: 1.10%
The BlackRock Strategic Income Opportunities Investor A (BASIX, $9.45) is an actively managed bond mutual fund that should complement core bond exposure to increase your risk-adjusted returns. Managers Rick Reider, Bob Miller and David Rogal have been with the fund for varying amounts of time, with Reider boasting the longest tenure in BASIX at roughly a decade.
This isn't your garden-variety bond fund. A little more than 20% of BASIX's assets are invested in "interest-rate derivatives" – hedges that institutional investors use against movements in interest rates. Another 19% is invested in emerging-market bonds, and the rest is split among debt such as junk bonds, Treasuries, collateralized loan obligations and more.
Performance is a mixed bag against the "Agg" bond index, though it's far less volatile than both the market and even the Nontraditional Bond category. But one thing weighing down its performance is high costs – not just a 1.1% expense ratio, but also a 4% maximum sales charge. But you can get around this if you have access to the Institutional shares (BSIIX), which have no sales charge and a 0.62% annual fee.
While an individual using a regular account would need to scrape together a whopping $2 million minimum initial investment, investors whose assets are managed by independent financial advisors might be able to access this share class for a far more reasonable minimum investment. You also might be able to access BSIIX via your 401(k) or other employer-sponsored retirement plan.
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>>> High-Grade Bond-Fund Outflows Hit $35.6 Billion, Smashing Record
Bloomberg
By Claire Boston, Olivia Raimonde, and Alex Harris
March 19, 2020
https://www.bloomberg.com/news/articles/2020-03-19/investors-pull-record-35-6-billion-from-investment-grade-debt?srnd=premium
Withdrawal dwarfs second-largest outflow of $7.3 billion
Record $249 billion added to government money-market funds
Investors withdrew an unprecedented $35.6 billion from U.S. funds that buy up investment-grade debt this week as the global market rout from the spreading coronavirus intensified. At the same time, a record $249 billion poured into U.S. government money-market funds.
The withdrawals from corporate high-grade debt blow through the previous record $7.3 billion outflow from last week, according to Refinitiv Lipper. Funds that buy junk bonds lost $2.9 billion in the five business days ended March 18, while leveraged loan investors withdrew about $3.5 billion.
Credit markets had another volatile week amid a worldwide meltdown in risk assets. Risk premiums on investment-grade bonds reached levels not seen since the financial crisis, while junk bond yields breached 10% for the first time in more than eight years.
”The number is off the charts, but so is the magnitude of this market correction,” Dorian Garay, a portfolio manager at NN Investment Partners, said in reference to the investment-grade bond outflows.
Despite the turmoil, investment-grade companies including Walt Disney Co. and PepsiCo Inc. seized moments of relative calm to issue new debt. Many firms selling bonds this week were doing so to reduce their reliance on the commercial paper market, where prices have risen rapidly amid a broad market seize-up. Lipper fund flow data covers investment-grade funds that manage about $1.3 trillion in assets.
“The flows into IG have been so steady over the past eight years, that it was like the farmer coming with a daily handful of grain to feed the turkey in the back yard,” said Gregory Staples, head of fixed income at DWS Investment Management. “Today what the farmer had in his hand was an axe.”
Investment-grade bonds are poised for another one of the largest weekly losses on record as spreads widen to crisis levels. The three most recent daily outflows from high-grade funds and exchange-traded funds are the largest on record, Bank of America Corp. strategists led by Hans Mikkelsen said in a report Wednesday.
Money-Market Funds
The Federal Reserve stepped in on Tuesday, announcing that it would reintroduce the Commercial Paper Funding Facility, a measure it used during the financial crisis to shore up short-term funding markets.
Total assets in government money-market funds rose to an all-time high of $3.09 trillion in the week ended March 18, according to Investment Company Institute data that stretches back to 2007.
The prior weekly inflows record of $176 billion was set in September 2008 during the financial crisis caused by the collapse of Lehman Brothers.
Prime money-market funds, which tend to invest in higher-risk assets such as commercial paper, saw outflows of $85.4 billion, the largest move since October 2016, according to ICI. Total assets fell to $713 billion.
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>>> Fed unleashes commercial paper funding to support non-bank companies
by Brian CheungReporter
Yahoo Finance
March 17, 2020
https://investorshub.advfn.com/secure/post_new.aspx?board_id=8141
The Federal Reserve announced Tuesday that it will open a commercial paper funding facility to support the financing needs of companies facing stress amid the coronavirus outbreak.
The facility will support rollovers of commercial paper, a commonly used form of unsecured, short-term debt issued to raise funds.
With businesses forced to close and with consumer activity capped by quarantines around the country, concern has built up over previous weeks that companies will not be able to find funding to survive the public health crisis.
The commercial paper funding facility will establish a special purpose vehicle (SPV) that will purchase unsecured and asset-backed commercial paper from eligible companies as long as the paper is rated A1/P1 as of March 17. The facility would be available to companies of various industries, not just banks.
“An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak,” the Fed said in a statement.
The facility was opened in coordination with the U.S. Treasury, which will provide $10 billion of credit production via its Exchange Stabilization Fund.
The Fed has taken a number of uncommon actions recently amid the coronavirus outbreak.
An emergency 50 basis point cut from the Federal Reserve on March 3 was not enough to stop market turmoil, and on Sunday night, the central bank made another abrupt announcement by slashing rates to zero.
Fed Chairman Jerome Powell said the central bank’s actions over the past two weeks did not calm financial conditions as policymakers hoped, spurring the second emergency meeting.
In addition to pushing rates down to zero, the Fed also restarted the crisis-era policy of asset purchases, announced U.S. dollar swap lines, and eased bank rules to encourage lending.
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>>> Fed to Widen Treasury Buying, Expand Repo to Ease Market Strain
Bloomberg
By Matthew Boesler
March 12, 2020
https://www.bloomberg.com/news/articles/2020-03-12/n-y-fed-to-conduct-purchases-across-range-of-maturities-k7ozy3u5?srnd=premium
The Federal Reserve took aggressive steps Thursday to ease what it called “temporary disruptions” in Treasury financing markets, flooding the market with liquidity and widening its purchases of U.S. government securities in a measure that recalls the quantitative easing it used during the financial crisis.
The Federal Reserve Bank of New York said in a statement that the moves were “to address temporary disruptions in Treasury financing markets” at the direction of Fed Chairman Jerome Powell in consultation with the Federal Open Market Committee.
U.S. stocks trimmed staggering losses of more than 8% earlier in the day as investors absorbed the Fed’s muscular decision.
The buying will include coupon-bearing notes and match the maturity composition of the Treasury market, it said. Ten-year U.S. Treasury yields fell sharply to trade around 0.68%.
“The Treasury securities operation schedule includes a change in the maturity composition of purchases to support functioning in the market for U.S. Treasury securities,” the New York Fed said.
Term repo operations in large size have also been added to help markets function, it also said. The New York Fed said it would offer $500 billion in a three-month repo operation at 1:30 p.m. and repeat the exercise tomorrow, along with another $500 billion in a one-month operation, and continue on a weekly basis for the rest of the monthly calendar.
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>>> Stampede Into Treasuries Sets Up Auctions at Record Low Rates
Bloomberg
By Emily Barrett
March 8, 2020
https://www.bloomberg.com/news/articles/2020-03-08/stampede-into-treasuries-sets-up-auctions-at-record-low-rates?srnd=premium
Haven rush pushes 10-year yields to unprecedented levels
ECB to meet Thursday with expectations divided on outcome
Flight-to-safety in the world’s largest bond market will take on new meaning this week, with some Wall Street firms considering contingency plans for the spread of the coronavirus.
While traders await updates on their working arrangements, there may be little standing in the way of the haven trade that drove the U.S. 10-year yield down to an unprecedented 0.66% Friday amid an equities rout. The market will be watching for further liquidity strains in Treasury futures, and how that might translate into demand for more haven assets at this week’s Treasury auctions. Over the weekend, Saudi Arabia declared an all-out price war in the oil market, adding to the wall of worries over a looming recession and signs of strain in credit markets that have driven investors to the safety of Treasuries.
The Treasury is poised to sell a combined $78 billion of coupon securities at historically low yields. Wednesday brings $24 billion of 10-year notes. To get a sense of the ferocity of the bond rally in recent days as fear over the virus’s impact intensified, the last auction of this maturity, on Feb. 12, drew a yield of 1.62%.
This week's 10-year auction could easily break prior record-low yield
“Given those moves we’re seeing in the 10-year, that implies to me there’s a lack of inventory out there and you’ve got to think the auctions will go well,” said Lee Ferridge, a macro strategist at State Street Corp. “The risk from here has to be that things get worse before they start getting better.”
He’s now looking for the 10-year yield to head toward 0.5%, from a closing level of 0.76% last week.
Relentless demand has taken the maturity’s price to lofty levels going into this week’s auction. The current 10-year carries a higher price than any reopening since 2009.
Friday’s market moves have already drawn comparisons with the financial crisis, though with less confidence that policy makers can do much to combat the economic impact of the disease.
Markets barely registered last week’s pledge from the Group-of-Seven that it was ready to act, and the emergency rate cut from the Federal Reserve. As for the robust U.S. jobs report, Columbia Threadneedle strategist Ed Al-Hussainy dismissed it as “roadkill for this rates market.”
The underwhelmed market reaction to the Fed demonstrated the difficult task facing European Central Bank Governor Christine LaGarde on Thursday. Economists are split on whether the bank will unleash monetary stimulus at this meeting, and hopes are building instead for some fiscal response.
In the meantime, market participants are fixated on what sort of liquidity conditions will greet them in what promises to be another turbulent week.
“Markets are functioning, but it seems to me that on a day when the 10-year yield is lower by 20 basis points, that’s not orderly, that’s a gap,” said Mike Schumacher, head of rates strategy at Wells Fargo Securities, referring to the most extreme levels in Friday’s trading.
“I wish I had more answers,” he said. “We all do.”
What to Watch
Fed officials are in a blackout period ahead of the March 17-18 meeting, but markets will be fixated on the message from the ECB on Thursday.
The New York Fed will release new schedules on March 12 for its Treasury purchases and repo operations
Here’s the economic calendar:
March 10: NFIB small business optimism
March 11: MBA mortgage applications; consumer price index; real average earnings; monthly budget statement
March 12: Producer price index; jobless claims; Bloomberg consumer comfort; household change in net worth
March 13: Import/export prices; Bloomberg U.S. economic survey; University of Michigan sentiment
The auction slate is busy:
March 9: $42 billion of 13-week bills; $36 billion of 26-week bills
March 10: $38 billion of 3-year notes
March 11: $24 billion of 10-year notes reopening
March 12: 4-, 8-week bills; $16 billion of 30-year bonds reopening
<<<
>>> JPMorgan Sees ‘Early Signs’ of Stress on Credit and Funding
Bloomberg
By Joanna Ossinger
March 7, 2020
https://www.bloomberg.com/news/articles/2020-03-08/jpmorgan-sees-early-signs-of-stress-on-credit-and-funding?srnd=premium
The fallout from the global spread of coronavirus may be starting to affect credit and funding markets, according to JPMorgan Chase & Co.
Supply-chain disruptions and demand shock from the virus fallout could already be causing cash-flow problems for businesses, JPMorgan strategist Nikolaos Panigirtzoglou wrote in a note Friday. That’s probably even more true for smaller companies and those in sectors like travel and lodging, he said.
“If these shifts in credit and funding markets are sustained over the coming weeks and months, especially in the issuance space, credit channels might start amplifying the economic fallout from the Covid-19 crisis,” Panigirtzoglou said. Unless “credit support by central banks and/or governments is broad, fast and direct, we note credit markets are facing an increased risk of the cycle turning with a lot more downgrades or even defaults over the coming months.”
Credit markets suffered their worst day in a decade on Friday amid fears that coronavirus will hurt corporate income and stymie some companies’ ability to repay their debt. Travel- and leisure-related companies were hit, while energy-company bonds and loans fell further into distress. A derivatives index that measures the perceived risk of corporate credit surged by the most since at least 2011 and in Europe the cost of insuring senior financial debt skyrocketed.
High-grade CDS index spread jumps by most since at least 2011
Market concerns about ratings downgrades and companies dropping to junk status are justified by a look at credit fundamentals, the JPMorgan report said. The median net-debt-to-Ebitda ratio for companies in JPMorgan’s high-grade and high-yield companies in the U.S. and Europe has risen steeply in the past decade and is now higher than in the previous two cycles in 2007/2008 and 2001/2002, it said.
“Companies are currently much more vulnerable to a decline in incomes and/or a rise in corporate bond spreads and yields than in the previous two recessions,” Panigirtzoglou wrote. “This is especially true for U.S. credit and for Euro high yield given the absence there of the backstop from the European Central Bank’s corporate bond program that solely benefits Euro high grade.”
There are some signs of stress in Yankee issuance as well, the report said, noting it tends to be more sensitive to funding concerns because non-U.S. companies can find it harder to raise dollar funding relative to domestic U.S. companies in periods of stress.
Read more: Europe’s ‘Zombie’ Borrowers Besieged by Spread of Coronavirus
It’s also the case that credit appears most vulnerable to an economic downturn, according to the note, using an analysis which looks at the historical behavior of various asset classes around past U.S. recessions, particularly the move from the pre-recession peak to the trough during the event.
relates to JPMorgan Sees ‘Early Signs’ of Stress on Credit and Funding
“Rate markets are now implying that something that looks like a U.S. recession is almost a certainty and have become even more disconnected from risky asset classes,” Panigirtzoglou wrote. “U.S. credit seems to be still most vulnerable to U.S. recession risks followed by U.S. equities.”
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>>> Hottest Bond Market in History Is Starting to Make Some Nervous
Bloomberg
By Cecile Gutscher and Anchalee Worrachate
March 3, 2020
https://www.bloomberg.com/news/articles/2020-03-03/hottest-bond-market-in-history-is-starting-to-make-some-nervous?srnd=premium
Duration bets at a record as coronavirus spurs caution
Haven play may turn dangerous if doomsday doesn’t come
Surging rate-cut expectations and a desperate lunge for safe assets amid the coronavirus outbreak have earned the bond market a lot of fans in recent weeks. The resulting rally is creating a few detractors, too.
A growing chorus of strategists and money managers is voicing concern as investors charge into government debt at seemingly any price.
The fear is they’re exposing themselves to interest rate risk like never before, risking a precipitous slump on even a modest bump in yields. One breakthrough in the fight against the illness, or a sign the global economy is recovering faster-than-expected, might be all it takes.
The yield on 10-year Treasuries touched an all-time low on Monday but traders didn’t have to look far for clues of just how fast the narrative can change. The S&P 500 Index surged 4.6% on bets central banks would coordinate to limit the economic impact of the virus. The moves highlight belief in some corners that policy action will stoke growth, creating upward pressure for stocks and bond yields.
“If things go a little better -- if there is a cure in the next two, three months or if with warmer weather the virus fades -- then long-end rates will sell off,” said Alberto Gallo at Algebris Investments. “Duration is expensive to protect the portfolio.”
The London-based money manager said he’s using short positions in credit to hedge the risk of a deeper sell-off.
Bond duration risk rises to record
Amid a rally so ferocious that it has stirred speculation some Treasury yields could even be headed below zero, the danger of rising bond yields still seems remote. Even those flagging it as a concern aren’t ready to unwind their bets on longer bonds -- for now.
The Federal Reserve’s announcement Friday that it was ready to act if needed took 10- and 30-year Treasury yields to new lows, with futures markets now pricing in more than 100 basis points of Fed cuts this year. The announcement by the Fed, a rare departure from typical central bank protocol, ushered in similar assurances from the Bank of Japan and the Bank of England.
The yield on the Bloomberg Barclays Global Aggregate Bond Index, which includes developed and emerging-market debt from governments and corporations, tumbled to 1.05% Monday, its lowest ever.
Global bond yields hit record low as investors seek virus havens
Still, the risks of taking one-way bets on bonds at such elevated valuations loom large. Sensitivity to changes in rates measured by duration is running at a record 8.6 years in the Bloomberg Barclays Global Aggregate Treasuries Index. That means every percentage point increase in average yields would spark a price decline of about 8.6%.
Bond traders throwing their faith behind policy makers should also be thinking about how steps to shore up confidence will affect those bets, according to Jim McCormick, the London-based global head of desk strategy at NatWest Markets. A boost to economic growth would ultimately mean higher long-dated yields.
“Central banks will likely cut and unlikely unwind them when things settle, but a recovery plus more fiscal policy should pressure the back end of the curve,” he said. “The curve steepens if the combination of policy response works.”
A sobering assessment by the OECD Monday did little to assuage market panic. The Paris-based group warned of possible global contraction this quarter and cut its full-year growth to just 2.4% from 2.9%, which would be the weakest since 2009.
As the number of new virus cases in China declines, those elsewhere are climbing, with countries like Brazil and Pakistan reporting instances of the illness for the first time.
But if measures to contain and stamp out the illness take hold, China returns to work and records an upswing in growth in the second quarter, bets on expensive government bonds may start to look dangerous.
Bond momentum signals tracked by a type of systematic investors known as trend followers have turned so extreme their bullish bets are now vulnerable to profit-taking, according to JPMorgan Chase & Co.
TLT posts its largest weekly outflow in more than a month
Wariness is reflected in passive flows in the world’s most heavily traded government debt product, the iShares 20+ Year Treasury Bond fund, which shows investors’ love affair with duration may be cooling somewhat. The ETF just posted its largest weekly outflow in more than a month.
“Chasing bonds when yields are at an all-time low seems very risky,” said Mark Dowding, a money manager at BlueBay Asset Management, who has a neutral stance on duration. “At the same time it seems that news flow on the virus will get worse before it gets better.”
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>>> Coronavirus Chaos Slams Credit Markets, Brings Deals to a Halt
Bloomberg
By Hannah Benjamin and Tasos Vossos
February 26, 2020
European bond market faces first day without deals in 2020
Warnings mount of hit to earnings as virus impacts growth
https://www.bloomberg.com/news/articles/2020-02-26/coronavirus-chaos-brings-corporate-debt-market-to-its-knees?srnd=premium
The global credit machine is grinding to a halt.
The $2.6 trillion international bond market where the world’s biggest companies raise money to finance themselves, has come to a virtual standstill around the world as the coronavirus spreads fear through company boardrooms.
In Europe, which had been enjoying the strongest ever start to the year -- with 239 billion euros ($260 billion) of bonds sold in January alone -- Wednesday saw no deals for the first time in 2020. The U.S. hasn’t seen a transaction since Friday while Asia, where the virus first emerged, has slowed to a trickle.
While such shutdowns are common during public holidays such as Christmas, they are extremely rare at other times of year.
Investors are rattled by the potential impact on company earnings from disruption caused by the virus, which has seen huge parts of global supply chains shutting down.
“It’s pretty serious,” said Shanawaz Bhimji, a fixed-income strategist at ABN Amro Bank NV, calling it a “very difficult” moment for investments in credit markets.
Deep Freeze
Coronavirus takes its toll on European primary bond market activity
Honeywell International Inc., Virgin Money UK Plc and Transport for London are among the European borrowers readying deals before financial markets started turning hostile.
Borrowing costs in euros for investment-grade companies have surged to 95 basis points, the highest level reached this year, according to a Bloomberg Barclays index, while default swaps insuring the debt of high-grade companies surged to the highest in four months. A closely-watched measure of risk in the junk-bond market also soared to a six-month high on Wednesday.
The number of coronavirus cases continues to climb, with the global death toll nearing 3,000. U.S. health officials have warned citizens to prepare for an outbreak, while South Korea has also emerged as a hot spot, with more than 1,000 reported cases there.
The worsening crisis is already taking a toll on companies’ balance sheets, with drinks maker Diageo Plc set to book as much as a 325 million-pound ($422 million) hit to organic net sales following significant disruption in Greater China since the end of January. French food maker Danone SA lowered its target for 2020 sales growth after slowing bottled water sales in China.
In the U.S., Mastercard Inc. shares tumbled as much as 7% this week after the company cut its revenue forecast as the spreading virus curbs international travel, while Apple Inc. said demand for iPhones in China tumbled 28% in January on the previous month.
Just four borrowers have visited Europe’s debt market so far this week, including ING Groep NV with a downsized sale of Additional Tier 1 notes on Monday. New deal announcements have also dried up, with only one mandate from the region yesterday.
Any sign that the epidemic is stabilizing may prove a fillip for sales, according to Luke Hickmore, investment director at Aberdeen Standard Investments in Edinburgh.
“We have seen before that any stability in markets tends to attract new issuance,” he said.
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>>> There’s a Wall of Cash Eager to Buy Treasuries on Any Price Dip
Bloomberg
By Liz McCormick and Ruth Carson
February 16, 2020
https://www.bloomberg.com/news/articles/2020-02-16/there-s-a-wall-of-cash-eager-to-buy-treasuries-on-any-price-dip?srnd=premium
It’s ‘a resilience play that makes sense’: BlackRock’s Thiel
Pensions, mutual funds and hedge funds have all piled in
Investors overseeing trillions of dollars are plowing money into U.S. government debt like never before, in a wave that’s only gaining strength as the spreading coronavirus casts doubt on the global growth outlook.
Evidence of the insatiable demand can be found across the fixed-income universe. Pensions, which have been ramping up bond allocations for more than a decade after a change in regulations, now hold a record amount of longer-dated Treasuries. Bond mutual funds saw a historic inflow of money last year, with no sign of a slowdown. Even hedge funds have piled in.
The wall of cash is a boon to American taxpayers as the federal deficit swells. It’s keeping Treasury yields, a benchmark for global borrowing, near all-time lows. With buyers ready to pounce, even surging stocks, record auction sizes and the tightest labor market since the 1960s can barely make a dent in bond prices.
“Treasuries are a resilience play that makes sense,” said Scott Thiel, chief fixed-income strategist at BlackRock Inc. “And so far, people have been rewarded for coming in and buying when yields get to the high end of the range.”
Investors have been buying on dips in Treasury prices
Just weeks ago, global economic reflation and the seeming inevitability of higher yields were the buzz among strategists and investors. The virus’s onslaught is unraveling that narrative, which already faced skepticism from those who argue that persistently low inflation and shifting demographics will pull yields lower.
“I expect the Treasury 10-year yield to fall to zero, perhaps within two years,” said Akira Takei, a global fixed-income fund manager at Asset Management One Co., which oversees more than $450 billion. “I’ve been overweight U.S. Treasuries. That’s based on my view that developed economies are facing a combination of aging demographics and falling birth rates, slow growth and low inflation.”
Investors snapping up Treasuries as an insurance policy have turned the U.S. yield curve on its head. With inflation still subdued and concern mounting that the spreading illness will damage an already fragile global economy, traders have boosted bets on Federal Reserve rate cuts in 2020. That prospect is in turn supporting equities.
The appetite for debt has extended to sovereign obligations of all flavors. One example: Greek 10-year rates once near 45% slid below 1% this month. The country’s junk rating is proving little deterrent with the world’s pile of negative-yield debt climbing above $13 trillion amid the latest global bond rally.
Benchmark 10-year U.S. yields have dropped to around 1.6%, from a 2020 peak of 1.94% in the first week of the year. The world’s biggest bond market has earned about 2.2% this year, after a 6.9% return in 2019 -- the best performance since 2011.
READ MORE
Bond Market Braces for Fresh Trillion-Dollar Fund Flow Wave
Bond Funds See Record Inflows After Virus Spurs Bets on Stimulus
Inverting Treasury Curve Shows Global Fear More Than U.S. Slump
“You still need a duration ballast and shock absorber,” said Con Michalakis, chief investment officer of retirement fund Statewide Superannuation Pty., which manages about $7 billion in Adelaide, Australia. “And I don’t see yields moving materially higher from here.”
The likely economic hit from the virus reinforces that view. Fed Chairman Jerome Powell last week cited the outbreak as a risk. Goldman Sachs Group Inc. predicts it will subtract two percentage points from annualized global growth this quarter.
“If the Fed is staying super-accommodative -- basically in reflation mode -- then you want to buy equities, credit and, strangely, you also want to buy Treasuries,” said Ralph Axel, an analyst at Bank of America Corp.
The demand for Treasuries in some corners has been building for years. U.S. corporate pensions, for example, have been big buyers since the federal Pension Protection Act, passed in 2006.
For the top 100 funds, with combined assets of more than $1.4 trillion, the fixed-income allocation surged to about 49% at the end of 2018 from 29% in 2005, as equities’ share fell by half to 31%, according to Milliman Inc., a pension and risk advisory firm. JPMorgan Chase & Co. strategists estimate the debt portion topped 50% as of December.
An up-to-date read on retirement funds’ demand can be seen in the record surge in Strips, which are created when Treasuries are split into principal- and interest-only securities. Pensions tend to favor these assets, which have longer duration, or sensitivity to interest-rate changes, to match the length of their liabilities.
Pension funds' Treasury demand seen in Strips rise
Soaring stocks are also spurring buying of bonds on price declines.
U.S. public pensions, with total assets of over $4 trillion, have kept holdings steady over the past five years, at about 25% in fixed income, 50% in public equities and the rest in alternative investments, according to data from the Pew Charitable Trusts.
As equities have climbed, the funds have needed to buy more debt to keep the breakdown stable, said Greg Mennis, director of public sector retirement systems at Pew.
Veteran bond manager Dan Fuss says he’s been been buying Treasuries as a safety play. He points to last week’s 10-year auction as a sign that yields won’t bust higher anytime soon. A measure of demand for the $27 billion sale was the highest since March.
“When you look at the bids for the 10-year notes, you’d have thought, ‘Wow, the government was giving out free ice cream’,” said Fuss, vice chairman of Loomis Sayles & Co. “There’s just more money available to invest than there’s marketable investment opportunities, and no risk of inflation at this time.”
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>>> Kraft Heinz’s Junk Downgrade Rekindles Bond Market Jitters
By Molly Smith and Jonathan Roeder
February 14, 2020
https://www.bloomberg.com/news/articles/2020-02-14/kraft-heinz-cut-to-junk-by-fitch-following-lackluster-earnings?srnd=premium
Packaged-food company cut to high yield by Fitch and S&P
More BBB debt has some investors wary that others may follow
Kraft Heinz Co., the iconic food giant created in a merger five years ago, was downgraded to junk by two credit raters, raising fresh worries among investors that a slowing economy could threaten the broader corporate bond market.
The packaged-food company was cut one level to BB+ by S&P Global Ratings, following Fitch Ratings earlier Friday. It will now become a so-called fallen angel, taking it out of investment-grade indexes.
Though Kraft Heinz, with just under $30 billion of debt, is a relatively small investment-grade issuer, it will become one of the top three in high yield. It’s just one of many companies that have wound up with a massive debt load as the result of deals, jeopardizing credit ratings in the process.
The food giant, created in a deal orchestrated by Warren Buffett and the private equity firm 3G Capital, is in the midst of a turnaround as its brands fall out of favor with consumers. It reported a drop in fourth-quarter sales Thursday that sent its bonds and stock tumbling, the latest sign that the company’s turnaround plan still has a long way to go.
“Kraft is to investment grade as Velveeta is to cheese,” said Christian Hoffmann, a portfolio manager at Thornburg Investment Management. “The ingredients dictate what something is and Kraft Heinz is junk.”
Profit Margins
That assessment is a far cry from the days of the merger when 3G went on a high-profile cost-cutting spree that was expected to eventually produce fatter profit margins. Instead, Kraft Heinz was left with a stable of tired brands and few new products that could appeal to consumers’ preference for more natural and less processed foods. Last year, it wrote down the value of its brand portfolio by more than $15 billion.
The turmoil has been a headache for Buffett’s Berkshire Hathaway Inc., whose stake over the past year has fallen to about $8.9 billion, down from $14 billion at the end of 2018. The stock was one of the worst performers last year.
S&P and Fitch cut the company one level to their highest junk rating. Kraft Heinz debt is already on the way to trading like junk. Its bonds due 2029 now yield about 3.5%, compared to the 2.88% for the average BBB company with similar duration. It’s the worst-performing issuer in both the U.S. and European markets Friday, and the cost to protect its debt against default has spiked to levels last seen in October.
Kraft Heinz bonds trade wider than BBB peers with similar duration
Fitch said Kraft Heinz may need to divest a sizable portion of its business in order to reduce debt. Kraft Heinz also needs to cut its dividend, Fitch said in August, but the company said Thursday it would maintain the annual $2 billion payout to shareholders. Fitch maintains a stable outlook, while S&P’s is negative. Moody’s rates the company one step above junk with a negative outlook as of Friday.
“We believe it’s important to Kraft Heinz shareholders to maintain our dividend during this time of transformation,” Michael Mullen, a spokesman for the company, said in an emailed statement earlier Friday. Kraft Heinz remains committed to reducing leverage “over time,” he said. The company plans to release a more detailed turnaround plan around the time of its next earnings report in early May.
Kraft Heinz was one of many companies with BBB ratings, the lowest level of investment grade, which now comprises half of the broader $5.9 trillion market. It’s grown steadily since the financial crisis, as a decade of low interest rates prompted companies to load up on debt for mergers and acquisitions, often at the expense of credit ratings.
UBS Group AG strategists led by Matthew Mish predict there could be as much as $90 billion of investment-grade debt to fall to high yield this year. That compares to just under $22 billion in 2019, close to a 20-year low, according to Bank of America Corp. strategists.
But a wave of fallen angels, which some investors fear, has yet to follow. Many strategists contend that BBB companies have the ability to defend their investment-grade ratings, whether by selling assets or cutting dividends. Companies like General Electric Co. and AT&T Inc. have done just that to stave off downgrades.
<<<
>>> Treasury Inversion Is Not About the U.S., It Is About the Whole World
Bloomberg
By Anchalee Worrachate and Liz McCormick
February 10, 2020
https://www.bloomberg.com/news/articles/2020-02-10/the-inverting-curve-is-flashing-global-fear-more-than-u-s-slump?srnd=premium
Safety grab may be bigger cause of inversion than U.S. outlook
Half of world’s haven pool is Treasuries: Eurizon’s Jen
The U.S. yield curve is flirting with another broad-based inversion again, reigniting Wall Street fears over the fate of the American economy.
A growing chorus of voices is being swayed by another notion: The signal might say more about the state of the world than the U.S. business cycle.
Treasuries now make up more than half of all global haven assets, double the share they accounted for during the financial crisis, according to Eurizon SLJ Capital. That complicates matters when long- and short-term yields flip: What used to be a reliable American recession indicator is instead an barometer of investors diving for cover worldwide.
It’s a narrative that makes a lot of sense as the threat from the coronavirus continues to grow, and it revives the frantic debate from last year about how much predictive power the curve actually has left.
Treasury yields flattening again as virus sparks global hunt for havens
“In a grab for safety and duration, everyone is going for U.S. Treasuries,” said Gregory Faranello, the head of U.S. rates at AmeriVet Securities. “The yield curve inversion is a signal now of global growth issues, and not really reflecting what is going on in the U.S.”
After a respite early last week the curve is once again flattening, and the gap between the rate on 10-year and three-month Treasuries narrowed for a third day on Monday. At the height of coronavirus angst and an equity sell-off at the end of last month it briefly inverted for the first time since October.
Bond yields typically rise alongside the duration of debt because they provide compensation for the effects of inflation. If rates on a 10-year note are lower than a three-month bill it suggests investors have a pessimistic view of growth and inflation a decade from now.
Stephen Jen, the chief executive officer at Eurizon SLJ, says global hunger for U.S. bonds helps explain American exceptionalism in growth, currency markets and stocks.
He predicts that by 2022, U.S. government debt will account for two-thirds of the world’s pool of haven bonds thanks to large issuance and quantitative easing by other central banks. His calculations are based on the outstanding amount of government debt in the U.S., Japan, and the three largest European economies, subtracting out the portion that is owned by central banks.
“The U.S. might, perversely, thrive because of troubles elsewhere,” Jen said in an interview. “When U.S. Treasury yields fall due to shocks outside of the U.S. that may or may not have an impact on the U.S. economy, it often provides added stimulus.”
It’s a view Federal Reserve officials are playing close attention to as global risks from the virus mount. In an interview with Bloomberg TV, Fed Vice Chairman Richard Clarida played down the inversion and said the negative spread is “really driven not so much by an outlook for the U.S. economy, but globally.” When there’s uncertainty money flows to America, he said, so current yield moves don’t reflect the U.S. outlook.
Campbell Harvey is credited with drawing the link between the slope of the yield curve and economic growth. The professor at Duke University’s Fuqua School of Business says corporate America is much more attuned to the yield curve signal and will take preventative action.
“CFOs and CEOs are more aware and aren’t likely to take on the risk of just ignoring it,” Harvey said. “They are being a little more cautious now.”
The gap between the yield on three-month and 10-year Treasuries recently slipped to as low as about minus 6 basis points. The spread -- which has inverted before each of the past seven U.S. recessions -- had initially fallen below zero in March 2019 as economic conditions deteriorated at the height of the trade war. The spread between two- and 10-year yields, which was negative as recently as September, remains above that mark at 17 basis points.
On Wall Street, strategists at JPMorgan Chase & Co. still see plenty of reason to fret the slope of the curve. Their favorite indicator -- and a part of the curve that remains inverted -- is the gap between two-year forward and one-year forward rates, which can shed light on the bond market’s expectations of what the Fed will do.
In this case, it shows a “rising probability of a more protracted Fed rate cut cycle extending to 2021,” said Nikolaos Panigirtzoglou, a strategist at JPMorgan.
For now, there aren’t many other alarm bells in an American economy with unemployment rates near 50-year lows and the longest stretch without a recession since World War II. Even so, economists forecast that GDP growth will slow to 1.8% compared with 2.3% in 2019, and it’s too early to determine whether the coronavirus outbreak in China will significantly affect the U.S. economy.
“When Treasuries become most dominant, investors from anywhere in the world naturally buy of lot of these bonds when they want a safe haven,” said Jen. “The yield curve in the U.S. is increasingly reflecting the fears of the rest of the world.”
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>>> High-Tax States’ Bonds Are So in Demand That Ratings Don’t Matter
Bloomberg
By Danielle Moran
February 6, 2020
https://www.bloomberg.com/news/articles/2020-02-06/high-tax-states-bonds-so-in-demand-that-ratings-don-t-matter?srnd=premium
‘To boil it down, it’s 99.999% because of the SALT cap’
California, New York yields holding below the AAA benchmark
There’s so much money chasing after the bonds sold by America’s high-tax states that buyers don’t seem to care too much about what credit-rating companies think.
The heavy demand overall has driven municipal yields to their lowest in more than six-decades. And with rates so low, the yield penalties that would typically differentiate a deeply indebted state from a thrifty one have become little more than rounding errors that in some cases contrast with their standing in the ratings pecking order.
California’s general-obligation debt, for example, is yielding about 1 basis points less than the AAA benchmark, even though the state is rated as many as four steps below that, according to data compiled by Bloomberg. New York, one step below AAA, is paying about 8 basis points less than top-rated borrowers. Over the past year, New Jersey’s yield premium has been cut nearly in half even though its rating hasn’t changed. Connecticut’s is roughly a third of what it was.
Both NY and CA debt yield less than top rated bonds
By contrast, bonds issued by AAA rated Texas and Florida, where there’s no state income tax, pay above-benchmark yields.
This dynamic shows how dramatic the demand has become for tax-exempt securities since President Donald Trump’s 2017 tax law limited state and local deductions. That change drove investors in high tax-states like California, New York and New Jersey into municipal bonds as an alternative way to drive down what they owe.
“To boil it down, it’s 99.999% because of the SALT cap,” said James Iselin, portfolio manager at Neuberger Berman Group LLC in New York. “Because there’s is so much demand in the market -- there is less of a credit differentiation that the market is making.”
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>>> Corporate Debt: A Slow-Motion Train Wreck
FEBRUARY 4, 2020
BY SCHIFFGOLD
https://schiffgold.com/key-gold-news/corporate-debt-a-slow-motion-train-wreck/
Corporate debt has blown through the roof over the last several years. So much so that the Federal Reserve has issued warnings about the increasing levels of corporate indebtedness.
Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”
But as Brandon Smith of alt-market.com noted in an article published at LewRockwell.com, this is a subject the mainstream media “seems specifically determined to avoid discussing these days when it comes to the economy.
Smith called corporate debt “the key pillar of the false economy.”
It has been utilized time and time again to keep the Everything Bubble from completely deflating, however, the fundamentals are starting to catch up to the fantasy.”
Business debt skyrocketed to a record $16 trillion in 2019. That represents a 5.1% year-on-year, much faster than economic growth. As a result, debt levels have also reached historic highs in terms of percentage of GDP. According to the Federal Reserve report, debt growth has outpaced economic output “through most of the current expansion.”
Smith pointed out that corporations have been using borrowed money for stock buybacks. He called this the single most vital mechanism behind stock market inflation.
Corporations buy their own stocks, often using cash borrowed from each other and from the Federal Reserve, in order to reduce the number of shares on the market and artificially boost the value of the remaining shares. This process is essentially legal manipulation of equities, and to be sure, it has been effective so far at keeping markets elevated.”
Smith said that corporate stock buybacks appear set to decline in 2020. But he doesn’t think this is because companies want to stop using the tactic. The problem is the amount of accumulated debt is outpacing falling profits. Corporate profits peaked in Q3 2018 and have been falling ever since.
Price-to-Earnings ratio, as well as the Price-to-Sales ratio, are now well above their historic peak during the dot-com bubble, meaning, stocks have never been more overvalued compared to the profits that corporations are actually bringing in.”
It’s not just that massive level of corporate debt that is worrisome. Much of the debt is categorized as risky. The Fed report expressed concern about the high level of leveraged loans and what it describes as “weak underwriting standards.” There are more than$1.1 trillion in leveraged loans outstanding. These are loans made to firms already deeply in debt. Think subprime loans for corporations.
A broad indicator of the leverage of businesses—the ratio of debt to assets for all publicly traded nonfinancial firms—is at its highest level in 20 years.”
As Smith points out, this level of borrowing always comes with consequences.
Even if central banks were to intervene on a level similar to TARP, which saturated markets with $16 trillion in liquidity, the amount of cash needed is so immense and the economic returns so muted that such measures are ultimately a waste of time. The Federal Reserve fueled this bubble, and now there is no stopping its demise. Though, they’re behavior and minimal response to the problem suggests that they have no intention of stopping it anyway.”
Peter Schiff has been saying the record stock market valuations have no real connection to the actual economy. He insists stocks really should be coming down and the only thing really supporting them is the Federal Reserve and all the money they’re printing with their QE program. Smith made a similar point.
While corporations, the Fed and Trump have been putting some effort into keeping stock markets from imploding, the real economy has been evaporating. Global import/exports are crashing, US manufacturing is in recession territory, US GDP is in decline (even according to rigged official numbers), US retail outlets are closing by the thousands, the poverty rate jumped in 30% of US counties in the past year, and high paying jobs are disappearing and being replaced with minimum wage service sector jobs.”
Smith called the corporate debt situation a “slow-motion train wreck.” And as he put it, a slow-motion wreck is still a wreck.
The damage can only be mitigated by removing one’s self from the train, and preparing for the fallout. Do not think that simply because the system has been able to drag it’s nearly lifeless body along for ten years that this means all is well. All bubbles collapse, and corporate debt has already sealed the fate of the Everything Bubble.”
<<<
>>> Ford’s Lending Arm Is Generating More Profit Than Ever
Bloomberg
Molly Smith and Keith Naughton
February 3, 2020
https://finance.yahoo.com/news/ford-lending-arm-generating-more-110001090.html
Ford’s Lending Arm Is Generating More Profit Than Ever
(Bloomberg) -- Aside from F-Series pickups hauling in gobs of profit, Ford Motor Co.’s automotive business isn’t carrying much weight lately.
Thank goodness for the finance guys.
Ford Credit, the lending arm that’s become accustomed to propping up the company in good times and bad, now generates about half the automaker’s profit, up from 15% to 20% in the past.
Ford Credit is designed to perform a relatively simple task: make loans to the dealers stocking vehicles, then the consumers who buy them. Now, Ford is relying on its finance unit to help fund multibillion-dollar outlays on electric and self-driving cars while it simultaneously racks up $11 billion in charges from a restructuring that could take years.
“It’s like the ballast that keeps the ship steady,” said Lawrence Orlowski, an analyst at S&P Global Ratings. “It’s a balancing act.”
Ford’s been selling fewer and fewer U.S. vehicles for the last three years, and it’s losing billions overseas, including in China, where its annual vehicle deliveries fell by half during that time span. On Tuesday, analysts expect the company to report lower fourth-quarter automotive revenue and a 44% plunge in adjusted net income. Profit on that basis could be the lowest since 2009.
Ford shares rose as much as 3.6% -- their biggest intraday in three months -- and traded up 2.7% to $9.06 as of 10:30 a.m. in New York. The stock rose 22% last year.
The second-largest U.S. automaker would be far worse off without its Ford Motor Credit Co. unit, which is effectively funding turnaround efforts by routinely borrowing in the debt markets and paying a dividend back to the parent company. The credit unit is expected to contribute almost $3 billion annually to Ford over the next two years, according to Benchmark Co. analyst Mike Ward. That’s up from just a $400 million contribution in 2017.
Ford Credit borrowed around $10 billion in the U.S. investment-grade bond market in the past year, apart from funds raised in other currencies and securitized debt. By contrast, it’s been more than three years since Ford Motor last issued bonds, according to data compiled by Bloomberg, as investors fretted about the company’s high debt load and slowing sales.
Credit graders are responding to Ford’s poor automotive performance, with Moody’s Investors Service the most aggressive so far. It downgraded Ford to junk in September, casting doubt on Chief Executive Officer Jim Hackett’s turnaround plan in the process.
S&P then cut Ford to the lowest investment-grade rating in October after the carmaker lowered its full-year profit forecast. Another downgrade by S&P would take Ford out of major high-grade indexes, which investors and analysts have contemplated for more than a year. If cut, Ford would be the largest U.S. nonfinancial high-yield issuer, which could add near-term pressure to its funding costs. It has about $35 billion of debt in the Bloomberg Barclays U.S. investment-grade index.
It’s not going to get any easier for the carmaker. Amid growing fears of an industry wide downturn, Ford is rolling out a critically important series of new sport utility vehicles and redesigning the F-150, its most profitable and best-selling model. Analysts are already flagging cost and execution risk tied to those introductions, especially after Ford botched the launch of its Explorer SUV last year.
“It’s quite clear Ford is not where it should be, but the finance arm is a bright spot,” said David Whiston, an equity strategist with Morningstar in Chicago who rates the automaker’s shares the equivalent of a buy. “Obviously you want the whole company operating at full power, which you don’t have right now.”
Ford Credit is contributing more and more to the parent’s earnings. In a normal operating environment, manufacturing cars and trucks should drive most of earnings, with credit only generating 15%-20% of profits, said Bloomberg Intelligence analyst Joel Levington. For much of last year, Ford Credit constituted somewhere around half the company’s profit.
Ford and its finance arm are inextricably linked. Each supports the other operationally and financially under a a relationship agreement that governs the connection between the two.
Ford Credit is also protecting the automaker’s prized dividend. The unit paid $2.4 billion back to its parent in the first nine months of 2019, covering the dividend cost for the entire year. That may be “unsustainable” in the long run, because Ford’s dividend consumes a much greater percentage of its cash flow than peers, according to BI’s Levington. Ford has repeatedly said it will not cut the dividend.
In a recession, Ford Credit’s role becomes even more important. It doesn’t play much in the subprime market, so the ratio of its losses to total customer bills outstanding stayed below 2% during the Great Recession, a low level. Its repossession rate never got higher than 3.2%.
Those strong metrics allowed Ford’s captive finance unit to generate a dividend for the parent even in 2009, when U.S. auto sales slumped to a 27-year low.
“With a healthy portfolio, a captive balance sheet in an economic downturn actually starts generating and kicking off a bunch of cash flow,” Tim Stone, Ford’s chief financial officer, said during a November interview at Bloomberg News headquarters in New York. “We take a very thoughtful approach to that business.”
Over the past two decades, Ford Credit has sent $28 billion up to Ford, according to company data.
“That’s not a bad thing -- that’s exactly the reason you want to have a healthy financial-services company,” said Hitin Anand, a senior analyst at CreditSights. “Ford Credit will come to the rescue of Ford Motor in more ways than one. It’s one of the best-run captive-finance companies in the entire universe.”
Finance companies can be a burden for manufacturers in downturns, as General Electric Co. discovered in the financial crisis. The conglomerate’s credit arm weighed on its share price as investors grew more concerned about complicated financial institutions. GE has been selling off and shrinking the unit’s assets for most of the last decade.
Ford Credit is a bright spot in Ford’s portfolio, and also among its peers. It prides itself on lending to consumers with higher credit scores, which keeps asset quality high and defaults low compared with rivals General Motors Financial Co. Inc. and Santander Consumer USA Holdings Inc.
In the third quarter, Ford Credit’s 60-day delinquency rate was just 0.14%. That’s low in an industry where 4.71% of auto loans were at least 90 days late, the highest in more than nine years, according to Federal Reserve data.
“As a credit analyst, I focus on glass half empty. Ford Credit is the positive part of the story,” said Olesya Zhovtanetska, senior director of public fixed income at SLC Management. “They need that cash cow.”
<<<
>>> Moody’s downgrades Ford credit rating to junk status
CNBC
SEP 9 2019
Associated Press
https://www.cnbc.com/2019/09/09/moodys-downgrades-ford-credit-rating-to-junk-status.html
Moody’s Investors Service has downgraded Ford’s credit rating to junk status.
The service says it expects weak earnings and cash generation as Ford pursues a costly and lengthy restructuring plan.
The ratings service said Ford’s outlook remains stable, but its cash flow and profit margins are below expectations and the performance of peer companies in the auto industry
Moody’s Investors Service has downgraded Ford’s credit rating to junk status.
The service says it expects weak earnings and cash generation as Ford pursues a costly and lengthy restructuring plan.
Ford responded with a statement saying that its underlying business is strong and its balance sheet is solid.
The rating for Ford’s senior unsecured notes and its corporate family dropped to Ba1, the top rating for debt that’s not investment grade. It had been Baa3, the lowest investment grade rating.
Ford’s fight to remain an American icon
Moody’s says it expects Ford’s restructuring to extend for several years with $11 billion in charges and a $7 billion cash cost.
The ratings service said Ford’s outlook remains stable, but its cash flow and profit margins are below expectations and the performance of peer companies in the auto industry. “These measures are likely to remain weak through the 2020/2021 period including a lengthy period of negative cash flow from the restructuring programs,” Moody’s Senior Vice President of Corporate Finance Bruce Clark wrote in a note to investors Monday.
Ford’s erosion in performance happened while the global auto industry was healthy, Clark wrote. Now the company and CEO Jim Hackett must address operational problems as demand for vehicles is softening in major markets, he wrote.
The company has $23.2 billion in cash, which is more than its debt, according to Moody’s. The stable outlook reflects Moody’s expectation that the restructuring will contribute to gradual improvement in earnings, profit margins and cash generation, Clark wrote.
Ford said it has plenty of liquidity to invest in its future.
“We are making significant progress on a comprehensive global redesign — reinvigorating our product lineup and aggressively restructuring our businesses around the world,” Ford’s statement said.
The statement said Ford already is addressing operating inefficiencies and problems with its China business.
<<<
>>> Debt-Laden Merchants Face Reckoning Amid Retail Apocalypse
Bloomberg
By Eliza Ronalds-Hannon
December 23, 2019
https://www.bloomberg.com/news/articles/2019-12-23/stores-that-stocked-up-on-debt-face-a-harsh-holiday-reckoning
Department stores fall out of favor with shoppers and lenders
Countdown is on for Forever 21’s plan to keep doors open
Retailers are strapping in for the final days of their traditional do-or-die holiday shopping period. For some, that could be meant literally, as creditors and vendors decide which ones are still worth supporting in a field plagued by fewer shoppers, more online competition and too much debt.
Some of the most familiar names -- Forever 21 Inc., Barneys New York Inc. and Payless Inc.-- have already collapsed into bankruptcy or liquidated this year. In 2019 alone, Coresight Research estimates, retailers have shut more than 9,300 stores. Among the survivors, fates have diverged, according to the restructuring experts at FTI Consulting Inc.
“The retail sector is becoming more segmented between winners and losers,” Christa Hart, a senior managing director in FTI’s retail and consumer practice, said in an interview. “The ‘average’ has disappeared.”
At Risk
Merchants could use a strong finish after last year’s holiday season, when retailers wound up with their worst sales drop for December since 2008, according to U.S. Census Bureau data analyzed by FTI. This holiday season “will be disproportionately great for the strong players and disproportionately weak for the other ones,” Hart said.
Some of the most vulnerable are the traditional department-store chains. Moody’s Investors Service predicted in a November report that by the end of 2019, those retailers will have seen their operating income fall by more than 15%. This, despite heavy investing to improve inventory efficiency and to build their online capabilities.
Department store sales have been declining for decades
“It’s not 1985 anymore,” said Perry Mandarino, head of restructuring and co-head of investment banking at B. Riley FBR Inc. “People don’t need a one-stop shop where they can get everything from vacuum cleaners to jewelry.”
Here are some retailers being closely watched by credit investors and lenders.
J.C Penney
Debt outstanding: About $4.2 billion
J.C. Penney Co. backed out of its appliance business earlier this year as one of the initiatives of new Chief Executive Officer Jill Soltau. She’s trying to design a strategy that will revive a chain suffering from slow-moving inventory and outdated merchandise.
Same-store sales, a key retail metric, dropped 9.3% last quarter. Foot traffic is falling and comparable sales have slid for five straight quarters.
Department stores should be focused on deepening their offerings in one particular area, such as appliances, FTI’s Hart said. “Sadly, many of these department stores took out their hardline and home businesses in favor of apparel, and now they are feeling the results of those decisions,” she said.
S&P Global Ratings cut J.C. Penney to CCC in August, noting that while the company doesn’t plan to file for bankruptcy, “we think an out-of-court restructuring is increasingly likely.” The following month, Bloomberg reported the chain is preparing for talks with its creditors on possible transactions to ease its debt burden.
A representative for the Plano, Texas-based retailer declined to comment.
Neiman Marcus
Debt Outstanding: About $5.7 billion
Neiman Marcus Group Inc. engineered an out-of-court note exchange in June that bought it more time to ease its high leverage.
But the luxury retailer still has about $700 million due by 2023, adjusted earnings continue to decline, and some of its bonds sell for a third of face value. Even the new debt issued during the exchange, which started trading at 97 cents, has already traded down to around half of its face value.
Credit raters take a dim view of Neiman Marcus. S&P said in June that the exchange didn’t make the debt load any less onerous and that there’s “continued risk of a restructuring or default over the next 12 months.”
The company is still mulling what to do with its successful European e-commerce business MyTheresa, and that may be its ticket back from the brink. It hired Lazard Ltd. in May to help it pursue a sale that could fetch more than $560 million.
A representative for the Dallas-based retailer declined to comment.
Belk Inc.
Debt outstanding: About $2.4 billion
Owned by Sycamore Partners LLC, this mid-priced chain concentrated in the southern U.S. typefies the pressures facing department stores, as shoppers seek out specialized outlets or take their household shopping online.
Belk is better off than some its peers, with a B2 rating from Moody’s. The credit rater cited a loyal customer base, better merchandising, good liquidity and stable cash flow in a June report. Another strength: About half its stores aren’t in malls, which are plagued by waning foot traffic.
Still, investors are shying from Belk’s term loan, which was quoted recently 71 cents on the dollar even after the company pushed its maturity out to 2025.
“Discount retailers are going to do better” than their higher-end peers in 2020, Mandarino said. “But they have to tailor their merchandise well. A lot of people have short attention spans, so you really have to cater to what your core buyer wants.”
A representative for New York-based Sycamore Partners declined to comment.
Forever 21
Debt Outstanding: About $350 million, excluding trade debt
Among all big retailers, Forever 21 Inc. may be the one whose survival is most at risk.
The trendy fashion chain went bankrupt in September, citing the cash-guzzling impact of an ambitious international expansion. Sales continue to lag, and revenue has been below expectations, Bloomberg reported in December. Inventory bottlenecks also threaten to curtail sales during the crucial holiday season, people familiar with the chain’s operations have said, making would-be rescuers hesitate to lend more money.
The company needs a new loan to finance its exit from bankruptcy, but prospective lenders are concerned about the weak results as well as the ongoing influence of husband-and-wife founders Do Won and Jin Sook Chang, who ran the company during its successful years as well as during its descent into insolvency.
A budget that Forever 21 filed with the bankruptcy court Nov. 16 cut its forecast for total sales in November to about $191 million, down 20% from what it predicted the month before.
A representative for Los Angeles-based Forever 21 declined to comment.
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>>> The Bedrock of Ultra-Low Yields Is at Risk
Bloomberg
By Emily Barrett, Chikako Mogi, and James Hirai
December 29, 2019
https://www.bloomberg.com/news/articles/2019-12-29/the-bedrock-of-ultra-low-yields-is-at-risk-as-fiscal-tide-turns?srnd=premium
‘The green shoots of fiscal spending are happening’: Loomis
Fragile growth, monetary action still curbing rise in yields
The new decade could be the dawn of a tougher era for bond investors, as conditions that sustained the historic bull run in government debt fall away.
Unprecedented central bank action has dominated economic stimulus since the global crisis and suppressed yields around the world. The skew may now be shifting more toward fiscal expansion that could pressure rates higher. Austerity is on the wane in Europe, spending packages are landing in Asia, and U.S. borrowing is on track for even bigger records in the next couple of years.
The handoff from monetary to fiscal policy is a longer-run investment theme, says Mark Dowding at BlueBay Asset Management, and he’s already trading it in the U.K., by betting against gilts.
“When you look at the U.K., what we’re witnessing now is some pretty material easing in fiscal policy,” said Dowding. “It’s a theme that we expect to see more broadly.”
The Organisation for Economic Cooperation and Development says government spending globally has helped widen the fiscal deficit from 2.9% of world gross domestic product in 2018 to an estimated 3.3% next year. Also, OECD economists are among the growing ranks pushing for more disbursements to tackle slowing global growth and climate change.
The trouble for investors is working out when government spending may reach a critical mass to push yields higher. As of now it’s still in fledgling stages, while central banks continue to pump massive stimulus.
“To me this is the story of the next decade,” said Elaine Stokes, portfolio manager at Loomis Sayles & Co. “The green shoots of fiscal spending are happening across the globe, but it hasn’t gotten to a place where it is coordinated.”
“In the next 5 to 10 years it becomes a factor in markets,” Stokes said. “So that’s where the market has to go -- we have to turn to a rising rate environment from a falling rate environment.”
From South Korea to Brazil, a Global Guide to Stimulus Plans in 2020
The risk of a reversal in the last decade’s trend of falling yields is palpable. The governments of the two largest economies are spending more, and relying on debt to plug much of their revenue shortfall. Alicia Garcia-Herrero, chief economist for Asia Pacific at Natixis SA, sees China’s issuance growing as the budget gap widens from 7.9% this year to 9% of GDP.
“Monetary policy has been less effective by itself, especially in the EU and China, the economy thus calls for more expansionary fiscal policy to grow,” said Garcia-Herrero, who previously worked for the European Central Bank and the International Monetary Fund. “One drawback of fiscal expansion is its upward pressure on interest rates.”
So far that pressure is barely registering in borrowing costs. The world’s benchmark, the U.S. 10-year yield, is mired below 2%, and $11 trillion of debt worldwide yields less than zero. While that total has shrunk by more than a third since August -- when global yields troughed -- investors continue to seize on assets that offer some return. And it still looks way riskier to trade against haven flows and central bank purchases while the global economic outlook remains fragile.
Global rates sell-off has shrunk the pool of negative-yielding debt by a third
That’s a popular and persuasive case against higher yields in the U.S. for now, even as lawmakers on both sides of the aisle look ready to embrace blowout deficits. The Treasury may manage to keep borrowing steady this year -- albeit at a record level -- in part because the Federal Reserve’s current plan to stabilize short-term funding rates could trawl roughly $240 billion of bills out of the market in the coming months.
Investors like Dowding are focusing on regions where monetary policy looks most exhausted. He reckons the market is overestimating the likely stimulus from the Bank of England. And his call in the U.K. isn’t an outlier -- Goldman Sachs Group Inc. strategist George Cole estimated that issuance to fund current spending and public-sector investment could be worth a boost of around 25-40 basis points in gilt yields next year.
Across the channel, ECB President Christine Lagarde is clearly taking up the push for more fiscal spending and may have more success than her predecessor. That said, expansive policy is emerging mainly in the peripheral countries, as a backlash against austerity. The region’s savers -- including its largest economy -- aren’t showing much sign of shifting their stance.
“We’ve seen this movie before,” said Brad Setser, senior fellow at the Council on Foreign Relations. “There is building pressure in Germany to increase investment and increase green investment in particular, but so far it hasn’t catalyzed an enormous shift in policy.”
Lagarde Eyes Dozen Euro Members With Precious Room to Spend More
In Japan, BNP Paribas SA sees increased government spending helping the 10-year yield edge up to +0.1% in 2020 from its current level just below zero.
But the Bank of Japan is scooping up bonds at such a rate, it’s still swamping fiscal efforts so far, according to UBS chief Japan economist Masamichi Adachi. This month’s $239 billion spending package may be only just enough to avert a recession following October’s sales-tax increase.
“The stimulus package isn’t a bold shift from the past and won’t significantly affect the outlook for markets or the Japanese economy,” Adachi said. “At most, it helps support confidence.”
But the rationale for higher yields is in place, at least in theory. S&P Global Ratings’ leading arbiter on the quality of the world’s government debt said that it’s gotten sketchier, as countries have seized on low interest rates to borrow more.
“You’re looking at close to 65 or 70% of world GDP that has today a lower credit quality than it had pre-2008 crisis,” said Roberto Sifon Arevalo. Government debt is “riskier today than it was before, but it’s not reflected in the market.”
Emerging markets have tended to pay a higher price for profligacy than developed economies with more room to spend, he said. And it’s worth remembering that when S&P cut the U.S.’s top-shelf credit rating, in 2011, Treasury yields plummeted as investors flooded into the world’s safest debt market. But the overall trend is clear.
“The market seems a bit complacent with the idea that interest rates will stay low for the foreseeable future,” said Sifon Arevalo.
<<<
>>> The Corporate Bond Market’s $100 Billion Buyer Is Here to Stay
Bloomberg
By Molly Smith and David Caleb Mutua
December 26, 2019
https://www.bloomberg.com/news/articles/2019-12-26/the-corporate-bond-market-s-100-billion-buyer-is-here-to-stay?srnd=premium
Foreign demand seen underpinning U.S. high-grade debt in 2020
Global investors flee $11 trillion of negative-yielding assets
The U.S. corporate-bond market’s $100 billion benefactor isn’t going anywhere in 2020.
Foreign demand will continue to underpin high-grade debt next year as global investors extend their hunt for higher-paying assets in the face of over $11 trillion of negative-yielding securities around the world, according to market watchers.
“There’s simply not enough high-quality income-producing assets to meet the demand,” Mark Kiesel, chief investment officer of global credit at Pacific Investment Management Co., said in an interview. “That’s the reason that credit did so well this year. It wasn’t just the fact that the Fed and other central banks cut rates. The fact is that there’s just that much demand.”
While hardly anyone expects a repeat of 2019, which has seen blue-chip company bonds return more than 14% -- the most in a decade -- many predict solid single-digit gains from a market they readily admit looks expensive by most conventional measures. That’s partly based on the expectation that money managers outside the U.S. will continue to pile in. They’ve bought $114 billion of bonds on a net basis this year through the third quarter, according to Federal Reserve flow of funds data.
Foreign Flows
Dealers have sold more bonds to non-U.S. investors than they've bought
Global central banks have cut interest rates roughly 90 times over the past year, the largest cumulative easing since the financial crisis, according to Canadian Imperial Bank of Commerce data. While the Fed accounted for three of those, taking its policy rate down to a range of 1.5% to 1.75%, that’s still higher than much of the rest of the developed world, including Japan and Europe, where rates are near or even below zero.
“It’s very hard for the average foreign investor to survive -- we’re still at a point now where it’s max desperation,” said Hans Mikkelsen, head of high-grade credit strategy at Bank of America Corp. “Basically there’s only one game in town for foreign investors, and that’s the U.S. corporate bond market.”
A lower fed funds rate also has its advantages. For one, it tends to make it cheaper for international buyers to protect against the risk of currency fluctuations. Three-month dollar-hedging costs based on forward contracts for euro- and yen-based investors have dropped significantly this year.
That’s “a positive for demand from those investors staying pretty strong,” said Barry McAlinden, senior fixed-income strategist for the Americas at UBS Global Wealth Management.
And if rates continue to decline, as some forecasters expect, that will almost certainly bolster demand for relatively higher-paying assets such as U.S. investment-grade company debt, market participants say.
The average U.S. investment-grade corporate bond yields 2.87%, or about 1 percentage point more than Treasuries. In Europe, absolute yields on company bonds sit at just 0.47%, similar to the 0.46% that Japanese corporate debt pays.
That’s why institutional investors like Japan’s Government Pension Investment Fund, the largest of its kind in the world, say they’re preparing to buy more bonds outside local markets.
“They are being pushed out of Japan,” said Tetsuo Ishihara, a U.S. macro strategist at Mizuho Financial Group Inc.’s fixed-income unit in New York, referring to Japanese institutional investors broadly. “There’s nowhere else to go.”
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>>> Apollo and Blackstone Are Stealing Wall Street’s Loans Business
Bloomberg
By Lisa Lee
December 18, 2019
https://www.bloomberg.com/news/articles/2019-12-18/apollo-and-blackstone-are-stealing-wall-street-s-loans-business
Growth of private credit comes at expense of leveraged lending
Apollo sees $200 billion of debt going private over five years
On the surface it was a classic leveraged takeover -- $1.8 billion of debt to fund the acquisition of Gannett Co. And just like hundreds before it, front and center was Apollo Global Management. Except this time, the private equity giant wasn’t the borrower. It was the lender.
The deal is part of a major shift occurring in global finance. Direct lenders, including more and more hedge funds and buyout firms, are preparing to dish out billions of dollars at a time to lure borrowers away from the $1.2 trillion leveraged loan market.
It’s the latest push by alternative asset managers into what was once the exclusive territory of the world’s biggest investment banks. And while Wall Street voluntarily ceded much of its business lending to medium-sized companies in the aftermath of the financial crisis, this time the iron grip it has on arranging the industry’s bigger loans is being pried open, jeopardizing some of its juiciest fees.
“Direct lenders have raised significant capital to allow them to commit to larger deals,” said Randy Schwimmer, head of origination and capital markets at Churchill Asset Management. “It’s an arms race.”
Investment returns from direct lending outpace gains from high-yield loans, bonds
It’s a striking reversal of fortune for syndicated-lending desks that spent the last 10 years luring business away from the high-yield bond market, the original source of buyout financing for big, risky companies. Even as recently as the beginning of the year, deals in excess of $1 billion were largely seen as the private domain of bulge-bracket banks, which arrange and sell them to institutional investors.
Not anymore.
Apollo said last month that it’s looking to do deals in the $2 billion range. Rival Blackstone Group Inc. is actively pitching a trio of billion-dollar financings that it intends to hold entirely itself, according to a person with knowledge of the matter. (The firm declined to comment.) And private-credit standouts including Owl Rock Capital and HPS Investment Partners are also setting their sights on bigger loans.
The $1.8 Billion financing of New Media Investment Group Inc.’s acquisition of Gannett came on the heels of a $1.25 billion direct loan by Goldman Sachs Group Inc.’s private-investment arm -- one of the few of its kind under a Wall Street bank -- and HPS to fund Ion Investment Group’s purchase of financial data provider Acuris.
And in October, a group of about 10 lenders including Owl Rock banded together to provide a $1.6 billion loan to refinance the debt of insurance brokerage Risk Strategies.
“There are bigger pools of capital” now, said Craig Packer, co-founder of Owl Rock, which controls more than $14 billion. “Our holdings of individual loans are therefore larger than was previously available from smaller lenders.”
Fading Fees
Investors have plowed hundreds of billions of dollars into private debt funds in recent years, lured by premiums that are more than five percentage points higher than competing public debt, according to a Goldman Sachs analysis.
Assets under management now exceed $800 billion, based on the most recent data available from London-based research firm Preqin, including over $250 billion of dry power. In contrast, leveraged loan growth has begun to stall, with the size of the U.S. market now hovering around $1.2 trillion, up less than 4% from a year earlier.
Partly as a result of direct lenders increasingly allowing borrowers to bypass the syndication process, compensation for arranging leveraged loans has plunged. Fees are down 29% this year through November, to about $8.5 billion, versus the same period last year, according to Freeman Consulting Services estimates.
The biggest players in the industry say the shift is just getting started.
Apollo predicts as much as 10% of the more than $2.5 trillion high-yield loan and bond market will go private over the next five years, John Zito, co-head of global corporate credit, said at the company’s Nov. 7 Investor Day.
The alternative asset manager sees the privatization of global credit mirroring a similar trend that’s swept equity markets in recent years.
In fact, many say the continued expansion of private equity will only help fuel the growth of direct lending.
“As private equity capacity increases, more deals and larger deals are being done in the private space,” Benoit Durteste, chief executive officer of Intermediate Capital Group, said in a report by the Alternative Credit Council last month. “This is why we are seeing larger and larger deals in private debt and the limits keep on being pushed.”
Growing execution risk in the leveraged loan market is also prompting buyout firms to increasingly turn to private sources of financing, according to market participants.
Loan buyers have been drawing a line and either bypassing or demanding significant concessions to lend to companies that may struggle in an economic downturn. On the flip side, private debt transactions can often be arranged in a fraction of the time it takes for a public-market deal, while limited scope for pricing adjustments provides sponsors with greater cost certainty.
Yet efforts to win deals away from investment banks, along with growing competition among direct lenders looking to deploy more than a quarter-trillion dollars of pent up cash, have some worried about weakening lending standards in the industry.
The club loan to Risk Strategies boosted the company’s leverage multiple to seven times a key measure of earnings, as much -- if not more -- than the issuer would have been able to get away with in the leveraged loan market, according to people with knowledge of the matter. While the financing includes a maintenance covenant, its terms are loose enough that the company would likely already be struggling to meet interest obligations before the safeguard is triggered, said the people, who asked not to be identified because they aren’t authorized to speak publicly.
“We are worried about how much debt has gone there versus going to the public market, and what that means in a downturn because there’s no liquidity” in private credit, said Elaine Stokes, a portfolio manager at Loomis Sayles & Co. in Boston. “That could seep into the public markets, if you end up having people becoming forced sellers.”
For others, the growth of direct lending is simply part of the natural evolution of credit markets.
“It’s part of a broader harmonization,” said Jeffrey Ross, chair of Debevoise & Plimpton’s finance group. “The broadly-syndicated loan market for the past 10 years has evolved to look and trade like high-yield bonds. There’s been a similar convergence between the middle-market and bulge-bracket lenders.”
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>>> Fuzzy Math That Fueled Junk Debt Boom Is Sparking Jitters
Getting creative with earnings adjustments helps sell deals.
Bloomberg
By Davide Scigliuzzo
December 13, 2019
Imagine walking into a bank to borrow money. The loan officer might ask for your pay stubs and tax returns to prove your income, as well as for information about your debts and monthly expenses to determine whether you’re a worthy borrower. If the numbers don’t add up, you’d be out of luck.
But what if you could convince your bankers that your income is higher than your stack of documents indicates? What if you promised some belt-tightening over the next couple of years that included moving to a cheaper neighborhood, getting rid of your gym membership, and cutting back on travel? Would they believe you?
In the mid-2000s—the heyday of “liar loan” mortgages—maybe they would have. But banks learned their lesson about taking too much on faith from consumers. For corporations, though, credit is easy again. Some of the riskiest borrowers, and the private equity firms often behind them, have been massaging a measure known as Ebitda—earnings before interest, taxes, depreciation, and amortization—to appear more creditworthy and take out bigger loans.
Money managers, regulators, and credit rating companies say they’re being vigilant. Even so, the fuzzy numbers may be creating a false perception of safety in the $2.5 trillion market for low-rated corporate debt. That market is a key source of funds for companies with less-than-stellar credit and for private equity firms, which typically load the businesses they acquire with debt to boost returns. Institutional investors have increased their purchases of high-risk loans and bonds over the past decade, as near-zero interest rates made other fixed-income assets less attractive. That demand helped make bigger and riskier loans possible. Matthew Mish, head of credit strategy at UBS Group AG, says even a garden-variety recession in the next year or two could cause earnings for the weaker borrowers to drop by as much as 40% from peak to trough, rivaling the declines seen during the global financial crisis. Such a meltdown of corporate balance sheets could fuel a cascade of defaults and bankruptcies.
Ebitda, which became popular in the 1980s as a tool for corporate raiders to better evaluate potential targets, has become a mainstay of corporate finance. It’s seen as a relatively direct measurement of a company’s ability to generate cash, because it strips out the effects of management’s decisions on capital investments and indebtedness. In theory it provides evidence of how much money the company could have available to service its debt.
Over the past several years, Wall Street lawyers and advisers have worked to squeeze generous adjustments into the Ebitda calculation, helping make purchase prices look smaller and debt loads more manageable. Exela Technologies Inc., a document processing company formed through the merger of SourceHOV and Novitex, relied on several rounds of adjustments to boost Ebitda when it borrowed money to finance the deal in 2017.
After removing interest, tax, depreciation, and amortization, plus some one-time costs, the company arrived at Ebitda of $247 million. In another round of adjustments, Exela counted expected benefits from shutting offices, cutting wrokers, and renegotiating vendor contracts. The resulting “further adjusted Ebitda” showed it pulling in $353 million for the 12 months ended on March 31, 2017. Based on generally accepted accounting principles, the combined company would have lost almost $63 million over that period. In a statement, Exela Chief Executive Officer Ronald Cogburn said it was important for investors to consider both a company’s current financial reporting and the potential beneficial impact of strategic planning on future plans.
In perhaps the most flagrant example of creative Ebitda, office-sharing company WeWork turned a $933 million loss into $233 million of what it called “community adjusted Ebitda” last year, when it issued its debut bond. The widely ridiculed—and since discontinued—metric excluded even basic general and administrative expenses. “We have never seen a net negative adjustment to Ebitda—it only goes up,” says Jason Dillow, CEO of Bardin Hill, a credit investment firm. “It is basically what can you get away with while keeping a semi-straight face.”
Professors Adam Badawi of the University of California at Berkeley and Elisabeth de Fontenay of Duke used a machine learning algorithm similar to those used to identify spam in email traffic to screen more than 4,000 credit agreements filed with the Securities and Exchange Commission from 2011 to 2018. Their study showed wide variation in how companies define Ebitda.
Take Del Frisco’s Restaurant Group Inc., the New York steakhouse chain. The company sought a $390 million loan last year to finance its acquisition of Spanish tapas chain Barteca Restaurant Group. It took Del Frisco 2,723 words to explain what Ebitda means, the most of any borrower included in the study. Its definition included 22 types of adjustments it could use to boost its reported earnings. By contrast, blue-chip companies such as chemical giant 3M Inc. and advertising agency Omnicom Group Inc. used less than 40 words for their Ebitda definitions. The most concise borrower used 10, barely enough to spell out the acronym. The simpler the definition, the less “creative” the Ebitda.
An overly complex definition can weaken protections for buyers of the company’s debt. That’s because key tests to determine if the company can take on additional debt, make investments, or pay dividends are typically calculated with Ebitda. “In instances where you have extraordinarily permissive language, it is much more like a self-certification than anything else,” de Fontenay says.
Ebitda inflation has picked up. In the first quarter of this year, companies issuing leveraged loans for mergers and acquisitions inflated their Ebitda by an average 43%, according to Covenant Review, an independent research firm that analyzes debt documents for investors. That’s the highest of any quarter in the data, which dates to 2015.
Evidence suggests that when companies make optimistic adjustments to Ebitda, disappointments are the norm soon after a deal is done. According to a recent study by S&P Global Ratings, companies involved in a merger or a leveraged buyout in 2015 missed their own earnings projections by an average 29% in the first year following the deal. For deals originating in 2016, the projections were off 35%.
Investors have already had a taste of what happens when things don’t work out as expected. Since 2017, Exela has been unable to improve earnings significantly with cost cuts and other moves, according to Moody’s Investors Service, which in November lowered Exela’s credit rating to Caa3, nine notches below investment grade. Exela’s profit margins have dwindled amid stiff competition, while charges for restructuring costs and goodwill impairment contributed to a net loss of $282 million in the 12 months ended on Sept. 30. Its bonds, meanwhile, dropped to just above 30¢ on the dollar. No reason to panic, though. The company says its further adjusted Ebitda is still growing.
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>>> Super-Rich Families Pour Into $787 Billion Private Debt Market
While banks are pulling back from lending, ultra-high-net-worth individuals are offering direct loans in return for high yields.
Bloomberg
By Kelsey Butler, Benjamin Stupples, and Marianna Duarte De Aragao
December 10, 2019
https://www.bloomberg.com/news/articles/2019-12-10/super-rich-families-pour-into-787-billion-private-debt-market?srnd=premium
Like many members of the global super rich, Monaco-based financier Evgeny Denisenko faces an investing challenge.
Four years ago, he came into a multimillion-dollar windfall when he sold an equity stake to a large Russian pharmaceutical firm. But in an era when central banks are keeping economies on life support with cheap-money policies and negative-yielding bonds, the traditional assets that used to preserve family fortunes are scarcer and less effective. That means the real value of many a nest egg is dwindling, leaving Denisenko to face the challenge of ensuring that future generations of his family are as rich as he is.
The solution, says the 29-year-old Russian, lies in a risky market for lending money to ventures and businesses viewed as too niche or outlandish by banks. “If you get the right deal, it’s one of the best asset classes at the moment,” Denisenko says.
Direct loans to far-flung oil exploration projects, luxury real estate projects, private equity-backed businesses, and cash-intensive tech startups can pay yields more than twice as big as the junk-bond market. That’s lured the likes of the Denisenko family and other members of the global elite such as former Los Angeles Dodgers owner Frank McCourt Jr. Stockholm-based Proventus Capital, which spun off from the family office of Swedish financier Robert Weil, is investing on behalf of wealthy clients, as well as institutional investors, in the market. More commonly, family offices are investing in the private credit market through funds. The Pritzker family, which owns the Hyatt hotel chain, and the Bill & Melinda Gates Foundation Trust have also put money into funds that invest in private distressed debt, tax filings show. Spokesmen for McCourt and the Gates Foundation Trust declined to comment. Requests for comment from the Pritzker family weren’t immediately returned.
Private credit has boomed globally as banks, under pressure from regulators since the global financial crisis to reduce risk, have pulled back from lending to smaller, potentially more vulnerable companies. The private credit market has expanded to $787.4 billion, from just $42.4 billion in 2000, according to London-based research firm Preqin.
Family offices—mini-investment firms set up by the super rich to manage their personal wealth—have poured more and more cash into direct lending, Preqin says.
Denisenko’s family office, known as Apolis, aims to deploy about $50 million per year around the world to companies from sectors such as outsourcing, oil, and real estate. As of October, 393 family offices were active in private debt, up from 129 in 2015, according to Preqin. This year, Axial Networks Inc., which operates an online forum to bring together lenders and borrowers, estimates that family offices on its platform will sign as many as 275 private credit deals in 2019, roughly a 15% annual increase.
The trend is likely to continue, according to findings from the Alternative Credit Council, which represents private credit asset managers globally. Its survey of firms managing $400 billion in private credit assets reported that half expect family offices to keep adding more money to private debt strategies over the next three years.
Tight Competition
There isn’t one playbook for investing in this market. “We like investing in places that are niche-y and capital short,” says Alan Snyder, founder and managing partner of Shinnecock Partners, a Los Angeles-based multifamily office. Shinnecock provides loans of $5 million to $25 million and focuses on such strategies as short-term bridge real estate lending, distressed municipal bonds, and lending against art assets. The art lending fund it set up about 30 months ago has made deals totaling $17 million and is getting more calls from people willing to lock up their artwork in storage as collateral for debt, Snyder says.
In addition to the tempting yields, the entrepreneurial flavor of lending directly to ventures in search of the rewards that come with bigger risks can also add to the appeal for families that became rich running their own businesses. “Appetite is strongest in asset-backed transactions or areas that are close to the family’s existing investments or operations,” says Robert Crowter-Jones, head of private capital at Saranac Partners, a London-based advisory firm for rich individuals and families.
But as the strategy’s popularity with billionaires has grown, competition for private loan deals has ignited. Family offices can move more quickly to sign new business than can bigger institutional peers such as pension funds, says Mark Sotir, president of Equity Group Investments, which manages Chicago billionaire Sam Zell’s money. EGI has loaned money to moving company Sirva Worldwide, oil and natural gas company Penn Virginia, and energy company Par Pacific Holdings, according to its website. “Debt is a tool in the toolbox, and we’re going to use it more in the future for sure,” Sotir says.
As the race to bag deals before rivals can get them intensifies, investors are also swallowing bigger risks when deploying their money, according to Snyder.
So-called middle-market lending, which involves loans of $50 million or larger, is overcrowded. More competition has also started eroding the yields that made direct lending appealing in the first place.
Michael Dean, of family office Bluelaurel, has felt the crush of competition firsthand. Avamore Capital, a property-focused lending company that Bluelaurel backs, initially produced double-digit returns four years ago. Surging interest in private credit has since halved those returns, Dean says. Still, he expects to maintain as much as 80% of his family’s assets in private real estate credit for now. “If the right opportunities arise, we’ll probably do some deployment back into direct real estate,” he says.
There are also liquidity risks. The underlying loans in private debt aren’t widely traded, which means they’re likely to be hard to sell in a crisis when markets turn volatile. In short, investors could find themselves looking on helplessly as their assets become worthless during a crash. Moreover, when investing in a closed-end fund with an asset manager, the capital is locked in with virtually no opportunity to withdraw until the asset matures.
“There’s a real reason the returns are as high as they are,” says Christian Armbruester, the founder of London-based Blu Family Office, who manages an open-end fund that contains more than 3,000 private loans worldwide. “If a borrower defaults, walks away, and the markets freeze up, you’re holding an asset you can’t move.”
But any concerns about deteriorating credit quality, tougher competition, or an impending downturn are failing to dent the popularity of private debt among investors in search of the yields it can pay. Debt will remain a big part of family office portfolios as they expand their footprint in private markets for the foreseeable future, according to Axial Chief Executive Officer Peter Lehrman.
“It’s really the next leg of progress by family offices in terms of their sophistication as direct investors in private markets,” Lehrman says. “I’m not surprised they started off investing in equity. And the fact that they’re increasingly putting capital to work and looking for opportunities in credit is a function of their sophistication.”
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>>> Why Fund Managers Are Scared of Sudden Withdrawals
Bloomberg
By Nishant Kumar and John Gittelsohn
July 10, 2019
https://www.bloomberg.com/news/articles/2019-07-10/why-liquidity-mismatch-is-scaring-the-bond-market-quicktake?srnd=premium
When M&G Plc, a U.K. property fund, announced it was freezing withdrawals on Dec. 4, mom-and-pop real estate investors were introduced to a term that’s already caused pain elsewhere in European bond and equities markets: liquidity mismatch. It’s what happens when funds that promise unrestricted redemptions put money into assets that are hard to sell in a pinch. That contradiction led the head of the Bank of England to warn earlier this year that some funds were “built on a lie.” Some observers compare the situation to a bomb hidden in the markets, ticking away and set to go off come the next downturn.
1. What’s causing mismatches?
For years, mom and pop investors have been pouring their money into mutual funds and exchange-traded products with the promise that they can get their money out anytime they want. At the same time, many funds that traditionally focused on liquid securities have been edging into more rarefied corners of the market to eke out returns in today’s world of low or negative interest rates -- a movement known as “style drift.” But many of those higher-yielding assets are in thin or quirky markets, making them potentially hard to trade. Real estate is perhaps the most illiquid asset of all, often taking months to unload.
2. Why is that such a problem?
Remember bank runs? Before deposit insurance, they were a regular occurrence because of the liquidity mismatch inherent in banks -- institutions that convert customer deposits available on demand into long-term investments. For investment funds, a sudden rush for the exits can create something similar. That can leave them with a choice of selling off assets at fire sale prices, potentially weakening themselves further, or closing the door to redemptions, a step that can erode market confidence more broadly.
3. What prompted these worries?
M&G froze its flagship 2.5 billion-pound ($3.3 billion) U.K. real estate fund after being hit by mounting redemptions. Carney’s comments came in June, after one of Britain’s most famous stock pickers, Neil Woodford, froze withdrawals from his flagship equity fund, and a global macro fund run by H2O, which is backed by Natixis SA, saw billions of dollar’s worth of withdrawals over investments in unrated bonds. Earlier, Swiss asset manager GAM Holding AG, froze redemptions in some funds after its dismissal of star bond manager Tim Haywood led to a rush of withdrawals.
4. Hasn’t this happened before?
Yes. In 2016, property funds stopped investors from taking out their money when withdrawals spiraled after the U.K. voted to exit the European Union. The M&G money pool was one of seven major U.K. funds managing more than $20 billion to halt trading at that time. To fix the problem, U.K. property funds -- which managed 29.3 billion pounds as of the end of October -- have been raising their cash levels. But the real estate market in the U.K. is slowing and the value of malls and stores, in particular, is plunging. That could make it even harder for funds to exit their bets, especially if they’ve offloaded their healthier properties first.
5. What’s driving it?
Something that’s referred to as “the reach for yield” -- and managers have been reaching further and further lately. Returns on safe assets plummeted in the 2008 financial crisis and have stayed low ever since. For example, as time has passed, many relatively straightforward U.S. bond funds have increased their holdings of lower-rated bonds, emerging-market debt and other securities, to juice returns. The trend led Morningstar Inc. to change how it classifies U.S. bond funds to make risk levels clearer. In April, it broke intermediate-term bond funds into two categories. Funds in “intermediate core bond” limit exposure to below-investment-grade assets. The second category is “intermediate core-plus bond.” At least eight of the “core plus” funds tracked by Morningstar reduced their allocation to government AAA rated debt between 2006 and 2018, while allocating more funds to assets rated BBB, the lowest investment grade rating given by Standard & Poor’s.
6. What are regulators doing?
The U.K.’s Financial Conduct Authority said it was working with M&G to ensure that “timely actions” are undertaken in the best interests of all the fund’s investors. The U.S. Securities and Exchange Commission has been concerned about mutual fund liquidity since at least 2015. The SEC now limits fund holdings of illiquid securities to 15%, and the funds are required to provide a confidential breakdown on the liquidity of their holdings to the regulator. As of June, they must also include a discussion on how they manage liquidity risk in annual reports to investors. Mutual funds in the U.K. are allowed no more than 10% of their assets in unquoted securities, a limit that Woodford’s now-frozen fund breached twice, according to the Financial Conduct Authority. On the other hand, the number of U.K. funds that have closed and blocked redemptions so far is relatively small compared with the hundreds of U.S. funds that close annually because of shrinking assets or investment losses.
7. How big a problem is this?
A lot of money is potentially at risk, though there’s debate over how acute the dangers are. Carney cautioned that the problems are “systemic,” with some $30 trillion tied up in illiquid or difficult-to-trade instruments. U.S. Federal Reserve officials have been warning about potential risks in leveraged loans and CLOs (Collateralized Loan Obligations) since 2013. “Widespread redemptions by investors, in turn, could lead to widespread price pressures,” Fed Chairman Jerome Powell said in May, “which could affect all holders of loans.” Others have pointed to liquidity issues with exchange-traded funds that focus on high-yielding loans and with direct lending funds, in which pools of investors make the kinds of loans to mid-sized companies that used to be arranged by banks. Defenders of bond ETFs point to the way they weathered previous bouts of market turmoil. But Michael Burry, an investor whose bet against the subprime bubble was featured in “The Big Short,” warns that “the theater keeps getting more crowded, but the exit door is the same as it always was.”
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>>> Record $2.4 Trillion Bond Binge Is Threatening Investor Returns
Bloomberg
By Finbarr Flynn
November 29, 2019
https://www.bloomberg.com/news/articles/2019-11-30/record-2-4-trillion-bond-binge-is-threatening-investor-returns?srnd=premium
Valuations are tight, little room for error: Aberdeen Standard
Drop in Treasury yields in 2019 helped boost investor returns
An unprecedented frenzy of debt sales around the world is threatening to cool this year’s hot returns on corporate bonds.
Companies have sold a record $2.43 trillion so far this year across currencies, surpassing previous full-year records. Investors rushed to snap up all this debt because they were desperate for yield as central banks cut rates. That has pushed up valuations.
Now, some troubling signs for the direction of those valuations are converging. Recent data suggest that the worst may be over for the global economy, which means many central banks could have less reason next year to guide down borrowing costs. That will all make it harder to top the double-digit returns that some investors scored on corporate bonds this year.
Corporate Debt Bonanza
Companies in 2019 rushed to sell debt across currencies as rates fell
“Valuations are tight in parts of the market, meaning there is not much margin for error,” said Craig MacDonald, global head of fixed income at Aberdeen Standard Investments. There could be “fairly muted positive returns, if you miss the problem credits, rather than the very strong returns of this year,” he said.
There are also some wild cards lurking: the ultimate course of U.S.-China trade talks, for starters. Signs of progress in the negotiations have buoyed financial markets in recent weeks, but political factors in the U.S. and China could make the path to any final agreement harder.
Geopolitical risks including North Korea, which tested more missiles in recent days, could also lead to more volatility.
Any shocks that pushed up financing costs would be of particular concern at weaker companies that have loaded up on debt. There are plenty such borrowers after bond issuance in Asia and Europe marched ahead at record pace this year, and U.S. debt sales remained high.
“The low hanging fruits are gone after a year of strong rally,” said Angus Hui, head of Asian credit and emerging-market credit at Schroder Investment Management (Hong Kong) Ltd.
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>>> Pensions Venture Into Risky Corners of the Market in Hunt for Returns
Wall Street Journal
by Avantika Chilkoti and Caitlin Ostroff
11-7-19
https://www.msn.com/en-us/money/retirement/pensions-venture-into-risky-corners-of-the-market-in-hunt-for-returns/ar-BBWq1Yi#page=2
Some pension-fund managers are venturing further into unusual investment territory as this year’s plunge in bond yields makes it even harder to find decent long-term returns.
Funds are dabbling in riskier asset classes, including private markets, real-estate projects, infrastructure financing and direct lending. Some are making riskier fixed-income bets, buying volatile assets such as 100-year Argentine government bonds. Others are going farther afield, investing in greenhouses and waste management.
“How do we get those types of return in an environment with low interest rates?” said Duncan Hale, a portfolio manager at Willis Towers Watson Investments, which offers insurance brokering, risk management and investment advisory services. He said he looks for tried-and-tested investment avenues that are “slightly outside of where you’ve seen pension funds usually invest.”
The giant pools of retirement money are under pressure to take on more risk following decades of declining interest rates that have chipped away at returns from their traditional bond-heavy portfolios. Those concerns have been exacerbated this year as yields on government bonds dropped sharply and central banks loosened monetary policy to stimulate economic growth.
Pension funds’ allocations to alternative asset classes rose to 26% in 2018 in the U.S., U.K., Japan, Australia, Canada, Switzerland and the Netherlands, from 19% in 2008, according to estimates from Thinking Ahead Institute, a research firm affiliated with Willis Towers. The allocation to bonds has remained steady at around 30%. That trend shows no sign of reversing, investors and analysts say.
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Falling bond yields hurt pensions by lowering a key metric called the discount rate, which measures the current value of a program’s future obligations to retirees. That forces the pensions to boost their assets to satisfy liabilities in coming years.
To help U.K. pensions generate steady returns, Willis Towers is advising its clients to invest in long-term property rental markets and infrastructure projects, as well as buying trains and leasing them to the government, according to Mr. Hale.
His fund backs a company that purchased land in eastern England for the construction of two greenhouses with a combined size of roughly 47 soccer pitches. Those will be leased out for 20 years to tomato growers and others, and are projected to generate annualized yields of more than 6% over the period.
Another project backed by the fund involves investing in a company that collects waste from London boroughs to be burned, helping generate electricity through turbines. Local authorities pay for the waste collection, while the electricity is sold back into the grid, according to Mr. Hale. The returns are expected to be more than 5% annually over 20 years, he said.
Some pension funds are moving into emerging-market debt—which can be volatile and sensitive to political headwinds—or less-liquid assets such as real estate.
One U.K. pension-fund client placed a sliver of its assets in the 100-year Argentine bond sold in 2017, according to Con Keating, head of research at Brighton Rock Group, an insurance provider for pensions. The bond currently offers a 27.712% yield, according to FactSet. In August, the value of those ultralong bonds fell by nearly half because of political uncertainty.
“This stuff really doesn’t belong in a pension fund,’’ said Mr. Keating. Because of the search for better returns, “you see all sorts of deals being done for all sorts of credit that wouldn’t ordinarily be touched,” he said.
The need to boost returns prompted Nest, a £8.5 billion ($10.9 billion) workplace-pension fund manager backed by the U.K. government, to make its first foray into private markets.
The firm is financing infrastructure projects such as toll roads and airports, and lending to commercial real-estate projects and buying collateralized mortgage-backed securities, through investments managed by Amundi SA and BlackRock Inc.
“It’s going to just become harder to eke out any returns from public markets,” said Stephen O’Neill, Nest’s head of private markets. With the new investments, “the main motivation is to try to pick up a private-credit premium—or liquidity premium—over the comparable bonds in the public market,” he said.
For pension funds in the Netherlands, the shrinking yields are a growing headache as they are required to surpass—and not just meet—estimated liabilities. Those that fall short must submit a recovery plan within a specified time frame.
APG, which has €440 billion ($486.9 billion) under management and oversees investments for the Netherlands’ largest pension fund for government and education employees, has less than 40% of its portfolio in fixed income, said Thijs Knaap, a senior strategist at the asset manager. Another 34% is in equities, 10% in real estate and 17% in alternative investment classes such as hedge funds and infrastructure. The firm, like many other pension funds, insurers and large investors, sees bonds as a crucial part of its portfolio because they can quickly be converted into cash, even if the returns are negligible.
“You have to work harder for your money,” said Mr. Knaap. “This means we’re taking on risk rather than the old situation of putting everything in bonds.”
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>>> This Red Alert Is Now Flashing on the Bond Trader’s Radar Screen
Bloomberg
By Liz McCormick
November 9, 2019
https://www.bloomberg.com/news/articles/2019-11-09/this-red-alert-is-now-flashing-bright-on-the-bond-trader-s-radar?srnd=premium
Last time this happened was during biggest sell-off since 2009
Longer maturity bonds in crosshairs as reflation trade builds
A bond-market warning light that glowed green for years is suddenly flashing red. The bad news for bondholders is that the last time this happened, it was accompanied by the biggest sell-off since the aftermath of the global financial crisis.
That indicator is the term premium, which, for both Treasuries and German bunds, has snapped back from last quarter’s record lows. The U.S. gauge is now on track for the biggest three-month increase since late 2016.
After a stellar rally through August, global bonds have pulled back in recent weeks as thawing trade tensions lightened the global economic gloom, sapping demand for the safety of sovereign debt. Rebounding term premiums now signal the sell-off has further to run -- the measure of extra compensation for holding longer-term debt versus simply rolling over a short-tenor security for years is in an uptrend that investors and strategists say has only just begun.
Term premium rebound adds fuel to Treasury yields' rise
The 10-year Treasury yield, a benchmark for world markets, climbed Thursday to a three-month high as investors’ animal spirits were sparked by the ebbing of the biggest headwind to global growth -- the U.S.-China trade war. That came as its German counterpart surged to levels unseen since mid-July and those in France and Belgium climbed back above 0%. The Japanese equivalent jumped Friday to its highest since May.
Investor are increasingly worried about holding longer-term debt as easing economic anxiety raises the prospect of a capital flight out of haven assets into riskier ones. Such a trend is already driving up yields, which, combined with the Federal Reserve’s signal that it will hold interest rates steady for the time being, is boosting term premiums. In Europe, a still-accommodative policy is bolstering inflation prospects, adding to the upward pressure on the gauge.
“Term premium was extremely depressed due to trade uncertainty, Brexit and you name it,” said Roberto Perli, a partner at Cornerstone Macro LLC. “These risks have abated so there is room for about a 50 basis point move higher in term premium. And given the Federal Reserve is on hold -- with no chance of lifting rates - there’s a lot of incentive for investors to take risk.”
Ten-year Treasury term premium has climbed about 42 basis points since the end of August, on track for the biggest three-month increase since 2016, according to the widely followed New York Fed ACM model created by Tobias Adrian, Richard Crump and Emanuel Moench. It rebounded this week to as little as minus 0.84% -- from a record low of minus 1.29% in August, the least for NY Fed data provided back back through 1961.
Understanding the trend in term premium isn’t just an academic exercise for bond wonks as it also helps gauge what’s driving debt yields and valuations. That margin of safety is one of three components that make up the yield of any given bond, according to former Fed Chairman Ben S. Bernanke -- the other two being market expectations for monetary policy and inflation. Basically, it’s an extra cushion against risk over the security’s relatively long lifetime.
READ MORE:
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To be sure, a resolution to the U.S.-China trade spat still looks far, with President Donald Trump downplaying Friday the amount of progress made in negotiations.
In Germany, the 10-year term premium began a swoon in mid-2014 after ranging from 100 to 250 basis points back since the euro was introduced in 1999, according to estimates by UniCredit SpA strategist Luca Cazzulani, using the methods as in the ACM model.
The gauge for bunds slumped to a record minus 100 basis points at the end of September before rising to minus 88 in October, according to UniCredit data updated at the end of each month. It has likely risen further this month.
“We have seen a continuation of upward in bund yields this month, and that should be related mostly to higher term premium,” Cazzulani said.
Long-term debt has a higher duration that those with shorter tenors. That means that for each move up in yield, prices will fall more sharply than for its short-term counterparts, increasing the risk of being in long-maturity debt.
QE Effect
The European Central Bank’s resumption of fresh bond purchases this month will exert marginal downward pressure on bund term premium, yet won’t be “a game changer,” according to Cazzulani. He estimates that quantitative easing will cause only a five basis point setback in the gauge, which would be too little to counter forces pushing it upward.
After cutting rates and unveiling debt-buying plans last month, the ECB has been pushing for governments to add budgetary support for growth. The prospects of fiscal stimulus along with an ongoing push for more European banking integration bode for more upside for term premium and yields in the region, according to Ronald van Steenweghen, a fund manager at a portfolio manager at DPAM.
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“Term premium was driven to levels that were difficult to explain unless you think the economic outlook is very dire, which we don’t agree with,” DPAM’s van Steenweghen said during an interview at the firm’s Brussels office. “And the potential positive feedback loop on the economy of fiscal stimulus is very, very high. This, with stable ECB policy, improving growth and reduced uncertainty all will work to push yields higher.”
The 10-year bund yield is on course to rise from about minus 0.26% to between 0.50% and 1% over the next one to three years, predicted van Steenweghen.
That leaves him “more confident with having a shorter duration stance.”
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