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Bond investors are placing ever riskier bets on the hunt for returns
(Bloomberg) – Bond investors, encouraged by a recovering economy and vaccine adoption around the world, are taking a higher risk, sometimes a much higher risk. Insurers, pension systems, and high-quality credit managers in the U.S. and Europe are buying larger amounts of junk-rated debt to offset falling yields, forcing high-yield investors to scramble for the allocation of BB-rated bonds – the safest and largest part of theirs Class with a market share of 60%. Some fund managers, used to picking speculative bonds, have cut their new bond orders in recent months and have declined to be identified as the information is private. A high-yield fund manager said its orders had been cut back by up to 15%. Rising demand has lowered returns to record lows and pushed investors into the subordinate parts of a company’s capital structure. It’s a gold mine for businesses looking to raise cash with the cost of borrowing falling and even those at greatest risk able to take out a loan and sometimes increase the size of their sales. “The market is hot and that is forcing investors to look more carefully at the opportunities because of the shortages,” said John Cortese, co-head of US loan trading at Barclays Plc in New York. “The traditional high-yield investor looking for a 5-7% return looks at parts of the credit markets with higher returns,” such as CCC-rated bonds, personal loans and even secured loan obligations, bundles of junk debt that Wrapped in Pieces Investors have amassed speculative debt to bet on what they expect in a roaring global economy in the second half of 2021 as more people get vaccinated. The US gross domestic product is projected to grow 6.1% this year, according to the latest Bloomberg monthly poll of economists. That would be the biggest growth rate since 1984. Projections for death from Covid-19 and other pandemic indicators have improved in recent weeks, although variants and a slower adoption of vaccines in the European Union complicate the picture. That optimism drove the U.S. junk down – bond yields. Average yields on US dollar-denominated CCC-rated bonds, the last credit rating before default, were 6.1% on Friday, their lowest level in existence. In Europe, CCC yields hit 5.8%, their lowest level since 2017, and a drop of a whopping 19% based on the height of the pandemic last year, ”said Matt Brill, Head of North America Investment Grade at Invesco Ltd. a $ 1.4 trillion wealth manager. “They think you’re getting a really interesting, attractive opportunity, and it still only pays 3.5% to 4.5%.” Contrary to his usual strategy, Brill dips into BB junk bonds with funds that are typically used for high-grade debt. As a result, traditional high yield investors have had to dig even harder for investment opportunities. Mark Benbow, a high-yield fund manager at Aegon Asset Management in the UK, said he has not made BB loans since mid-last year. We need to look at riskier names, ”said Benbow. Currently, only 24% of his fund is BB rated, compared to 60% in 2017, and he has increased his exposure to CCC credit. Central banks are currently supporting the financial markets with low interest rates and a simple monetary policy. The European Central Bank announced on Thursday that it would step up its emergency bond purchase program, further support for the economic recovery. However, rising government bond yields, triggered by a surge in inflation projections, mean sentiment could change quickly. For those burdened with riskier debts, the margin for loss is much greater. “With spreads and yields so tight and the lack of diversification in the market right now, there is very little upside, but a lot of downside. Don’t go according to plan,” said Jeff Mueller, London-based co-director, high yield at Eaton Vance. who helps manage $ 486 billion in assets. Bank of America preached caution in a notice to customers last week. The purchase of corporate bonds by investors keen to capitalize on the post-pandemic recovery has made some parts of the market look “noticeably stretched”. Still, buying pressures for riskier debt has been relentless, aided by a surge in junk bonds from pension funds and insurance companies, usually more conservative investors. According to a person familiar with the matter, these institutions are increasing their orders for BB-rated bonds by up to 30% year over year. According to government records, insurance companies, including Manulife Financial Corp. and Allstate Corp., among the largest holders of CCC bonds from Carvana Co. issued last fall. Carvana, a used car dealer, has never made a quarterly profit. In Europe, insurance funds have bought significantly larger portions of junk bond new issue businesses than they did last year. US pension funds are also targeting high-yield debt. The California Public Employees’ Retirement System and the Kentucky Public Pensions Authority, according to their annual reports, bought 11.75% of American Airlines Group Inc.’s junk bonds last summer that were issued due to the uncertainty surrounding the pandemic. Stakes World of Junk Troubled Borrowers The borrowers who capitalize on this hunger for return are a who’s who of businesses in trouble. German beauty retailer Douglas GmbH recently raised a € 2.4 billion refinancing, with investors overlooking declining sales and closed stores. A Douglas representative did not respond to an email and voicemail for comment. In the United States, Chuck E. Cheese’s parent company, CEC Entertainment Inc., issued $ 650 million in junk bonds in April, less than four months after bankruptcy. Moody’s Investors Service gave the bonds a Caa1 rating, placing them in the riskiest category, and found that CEC has “very high leverage and poor sales trends in the same business”. Investors remained undeterred, placing so many orders for bonds that CEC increased the size and reduced the interest payment to 6.75%. The bet is that a downturn is years away. “We are probably two to three years from the start of a traditional standard cycle,” Michael Arougheti, chief executive officer of Ares Management Corp., told a Bloomberg News virtual event earlier this month. (Updates with a review comment in Section 12.) For more articles like this, please visit us at bloomberg.com. Sign up now to stay up to date with the most trusted business news source. © 2021 Bloomberg LP