By Matt Wirz
Not too hot. Not too cold. Just right. Junk bonds started out
2015 with a Goldilocks-like first quarter, as persistently low
interest rates kept the market relatively stable, while a selloff
in energy-company debt provided ample opportunity for bargain
hunters.
Those conditions fed a deal surge as companies rated below
investment grade sold $93 billion of new bonds in the U.S., up
about 40% from the fourth quarter of 2014, when investor concerns
about the energy industry chilled market activity. The benchmark
Barclays U.S. Corporate High Yield index returned 2.49%, compared
with a 1.17% loss in the previous quarter.
While junk issuance rebounded from the fourth quarter, it fell
short of a record. The dollar value of U.S. bond sales by
investment-grade companies rose to a new all-time high in the first
quarter, driven by low rates and corporate deal making.
Part of the gains for junk bonds can be attributed to growing
complacency among investors about the risk that the U.S. Federal
Reserve will raise interest rates in the near term. Bond yields
typically rise, making prices fall, in anticipation of a rate
increase, but U.S. Treasury yields declined this year, as
expectations of an increase faded.
Falling yields boosted prices of existing bonds and prompted
companies to keep issuing bonds while the cost of borrowing
remained cheap. "We thought the refinancing trade by borrowers
would dissipate with rising rates, but it continues," says Stephan
Jaeger, co-head of leveraged-finance capital markets at Bank of
America Merrill Lynch.
Early in the year, such deals were dominated by high-yield blue
chips like HCA Holdings Inc. and H.J. Heinz Co. Less-stable
borrowers started to tap the markets in mid-February, when
investors recovered their appetites for risk.
Junk bonds tumbled in the second half of 2014 as oil prices fell
by almost half. That raised concerns that energy firms--which
Standard & Poor's Ratings Services says make up 9% of U.S.
companies with high-yield ratings--would struggle to repay their
debts. Bonds of energy companies with higher credit ratings, like
California Resources Corp., fell to 80 cents on the dollar. Debt
prices for lower-rated issuers, like EXCO Resources Inc., fell to
55 cents.
Bargain investments have been hard to find in recent years, as
low interest rates have helped pump stock and bond prices to
records. For many fund managers, the turmoil caused by low oil
prices is like water in the desert.
"It's been a good market for us," says Andrew Susser, who runs a
$21 billion portfolio of high-yield bonds for MacKay Shields, a
unit of New York Life Insurance Co., and owned few energy bonds in
December. He has since bought in at discount prices. "We've slowly
dialed up the risk the last couple of months."
When oil-producer Comstock Resources Inc. issued a $700 million
bond to pay off loans and pad its cash cushion in early March,
MacKay Shields was one of the funds that bought in, for a price.
Comstock agreed to pay investors a 10% annual yield on the bonds,
which are secured by the company's assets.
Such risk premiums are increasingly rare in fixed-income markets
across the globe. The European Central Bank's initiation of a
bond-buying program, or quantitative easing, to stimulate economic
activity has pushed yields on European bonds to record lows, with
the German government selling five-year bonds at negative yields
for the first time.
One side effect of Europe's lax monetary policy: The money that
fled U.S. high-yield bonds last year has started to flow back in.
Investors poured about $9 billion into junk-bond mutual funds and
exchange-traded funds in the first three months of the year,
partially offsetting the $12.75 billion they took out in the second
half of 2014.
In contrast, investors continue to yank money out of funds that
buy so-called leveraged loans made to companies rated below
investment-grade. Leveraged loans returned about 2.3% through March
30, according to Barclays, comparable to the performance of
high-yield bonds. Nevertheless, investors pulled about $3.24
billion from funds that buy the loans, adding to outflows of about
$17.58 billion in the second half of last year, according to
Lipper.
Because loans pay variable interest that moves in tandem with
prevailing interest rates, individual investors view them largely
as a hedge against rate increases by the Fed. Anticipation of such
a move prompted record inflows of $70 billion in 2013, according to
S&P Capital IQ LCD, but when the feared rise in rates failed to
materialize, investors started to lose interest.
"Collectively, we've cried wolf one time too many," says Frank
Ossino, a loan-fund manager at Newfleet Asset Management LLC.
"There's a large investor community that only buys loan funds when
rates go up."
Write to Matt Wirz at matthieu.wirz@wsj.com
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