Salient to Investors:
Wall Street firms are once again selling debt that may be poised to lose value. Wall Street is selling junk bonds at a record pace after they returned 19 percent in 2012, but says it’s obvious that prices will drop when interest rates rise. The amount of junk bonds underwritten so far in 2013 is 36 percent higher than the same period in 2012.
Debt underwriting was among the fastest-growing revenue lines for the world’s 9 biggest investment banks in 2013, some 40 percent to 63 percent of advisory and underwriting revenue. Banks earned an average 1.4 percent fee on dollar-denominated high-yield debt in 2013 versus 0.54 percent fee on all investment-grade issues.
Junk-bond ETF holdings have risen to $30 billion in less than 6 years, attracting $2 billion in January – these funds must buy junk bonds, helping support the market. Morningstar said investors poured $33 billion into mutual funds and ETFs dedicated to junk bonds in 2012, 55 percent more than in 2011.
Craig Packer at Goldman Sachs said our job first and foremost is help companies – the interest-rate risk is just a law of nature. Packer said the Fed is telling you to take the risk, and investors are but it’s a risk that’s bound to backfire, and 5 years from now we’re going to look back and realize that investors were taking on real interest-rate risk when they were buying any of these products and that risk came to fruition.
Marc Warm at Credit Suisse says investors and underwriters in the junk bond market are showing credit discipline, while the rate environment is more of a risk. Debt underwriters and investors say they don’t know what might happen if Treasury yields climb by more than a percentage point or two.
The Bank of America Merrill Lynch Global High-Yield Index shows the spread between junk bond yields and government debt has fallen 16.69 percent since 2008 to 5.24 percent.
Economists expect 10-year T-yields to rise less than a percent through half1 2014.
William Demchak at PNC Financial Services expects long-term rates to rise before the Fed starts raising rates as the long end of the curve gets out of their control – will happen sooner than people expect.
The Treasury Borrowing Advisory Committee warn that the Fed’s policies may be inflating bubbles in speculative-grade bonds and other asset classes.
Jeanne Branthover at Boyden Global Executive Search said managing directors in debt capital-markets units at the top banks were awarded bonuses ranging from $600,000 to millions of dollars.
Michael Holland at Holland & Co. said we have never had a situation like this because it is totally manufactured by the Fed – the prices of bonds acting like dot-com prices. Holland said the smartest fund managers — a small handful — are closing their doors to new money, but most managers continue to take the money and invest it, a la the dot-coms. Holland cited the maxim that more money has been lost reaching for yield than at the point of a gun.
Roy Smith at NYU said banks are not supposed to make up their minds for their customers as to what’s good for them – they are to supply them with what they want.
Moody’s Investors Service said borrowers are selling speculative-grade bonds with the weakest covenants in at least 2 years.
Stanley Martinez at Legal & General said his firm has rejected 75 percent of high-yield offerings in 2013 on concern that companies borrowed too much and debts may lose their value. Martinez said some offerings of high-yield loans and term bonds coming in 2013 and 2014 will be the raw material for the default cycle of 2015 and 2016.
Bob Jacksha at New Mexico Educational Retirement Board is positioning for an increase in junk-bond defaults and interest rates. saying it could be building into a bubble if not already one.
Some of the world’s most sophisticated investors have sounded alarms about the prices of fixed-income investments, including Warren Buffett who says bonds should come with a warning label because such low-yielding investments would be eaten away by inflation. Jeremy Grantham at Grantham Mayo Van Otterloo said some stocks are brutally overpriced while fixed income is “fugetaboutit”.
Howard Marks at Oaktree Capital said investors are buying debt with a 6 percent yield that they would not have bought 5 years ago at 10 percent.
Dan Fuss at Loomis Sayles Bond Fund said the fixed-income market is the most overbought market he has ever seen and that interest rates will rise.
Economists expect the Fed to keep rates unchanged at least through mid-2014.
Richard Zogheb at Citigroup said investors are well aware of interest-rate risk, and so strongly prefer larger, more-liquid issues which they can sell if rates start to move against them.
The Bank of America Merrill Lynch Global High-Yield Index has produced a 1.65 percent total return, which includes interest income and price gains, so far this year after a 19 percent return last year. The index is composed of 3,147 issues with a face value of $1.66 trillion.
Dan Toscano at Morgan Stanley said if you’re a long-only manager – a large chunk of the market – you’re effectively shorting the market if you sit in cash, and the opportunity cost of shorting can be very high. Toscano says there is not much conviction out there that this market will change tonight or tomorrow night.
Gary Cohn at Goldman Sachs says interest rates can only go up and is concerned the public may not understand how that could imperil fixed-income investments.
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