February 18, 2013 6:19 pm

Funds in two minds on junk bonds

Europe’s top fixed income fund managers are increasingly concerned about the credit fundamentals for global “junk” bonds but are still optimistic that prices have further to rise due to ultra-loose monetary policy, according to Fitch Ratings.

A survey of managers overseeing about $7.6tn worth of assets found that 40 per cent expected deteriorating fundamentals for non investment-grade companies, more than twice the number expecting an improvement.

But at the same time nearly a third said high-yield debt was their favourite asset class, more than double the last quarterly survey in October and the highest percentage figure in two years.

The contradictory indicators come amid fears that easy monetary policy around the world is creating a bubble in the junk bond market, with investors driven into the asset class due to low government yields rather than fundamentals.

In Europe, junk bond yields, which move inversely to prices, have fallen to less than 6 per cent for the first time in recent months, following the promise by the European Central Bank to intervene and do “whatever it takes” to save the eurozone.

In the US, junk bond yields have also fallen near all-time lows. Accommodative central bank policies has left fixed income investors hungry for risk and looking for higher-yielding investments.

There has been a strong rise in demand for esoteric boom-era financial instruments with relaxed credit discipline such as paid-in-kind notes as well as more “covenant-lite” bonds.

That has led to concerns many investors are mis­pricing risk in the search for yield.

Cecile Durand-Agbo, leveraged finance director at Fitch, says: “It is typically the stronger issuers that complete their refinancing first in a strong market, so as time goes on more and more funds are likely to buy credits from companies with a weaker profile if they want the asset class.”

In recent weeks some of the larger investors, including Pimco, BlackRock, Apollo Global Management, Centerbridge Partners and Oaktree Capital, have started to worry that the recent rally in high-yield might be overdone and have been paring their holdings.

Some have been taking short positions in the market, betting that the price of junk bonds will decline. Some retail money has followed, with outflows of $329m from US high-yield funds during the week ending February 13, according to data provider EPFR.

Pension funds have been growing more wary of corporate credit. “Many pension fund managers are taking their foot off the gas a little with buying corporate credit, looking at other assets such as loans or emerging market debt,” said Peter Ball, managing director at JLT Investment Solutions, which advises pension funds.

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