(Bloomberg) — Big investors like BlackRock Inc. and KKR & Co. Inc. think junk bond and leveraged loan prices look cheap, and are slowly buying even if there’s a good chance that markets will oscillate wildly in the coming months.
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High-yield companies still have relatively strong balance sheets, and defaults probably won’t surge even in a recession, said Mitchell Garfin, co-head of leveraged finance at BlackRock.
Even after rallying in July, US junk bonds have weakened about 10% this year, accounting for both interest payments and price movements, according to Bloomberg index data. Leveraged loans have fallen too: The average price was 93.6 cents on the dollar on Thursday, compared with 98.6 cents at the end of 2021.
Money managers are buying at a time when analysts at banks are cautioning that corporate bonds could be due for more pain. UBS Group AG strategists said this week that US junk bond spreads could widen to 650 basis points, or 6.5 percentage points, in the third quarter from 488 basis points on Thursday. Barclays Plc strategists said last week that spreads could reach “recessionary levels.”
That’s why few investors are arguing that it makes sense to back up the truck now. They’re instead recommending a slow ramp-up in purchasing, because timing when the market bottoms out is difficult.
“What we try to be mindful around is that these are still very fragile times, very unprecedented times,” said Anders Persson, chief investment officer for global fixed income at Nuveen. “We would expect some volatility here going forward.”
KKR & Co. (AUM: $479 Billion)
“Credit seems attractive on a long-term basis and particularly very attractive relative to equities today,” said Chris Sheldon, co-head of credit and markets at KKR. “Fundamentals are going to slow and will continue to slow, however, we are not anticipating a massive spike of defaults.”
Now is a good time to start buying individual high-yield bonds that look cheap, according to Sheldon. “It’s a walk don’t run,” he said. “Spreads will definitely be wider at some point.”
He also likes leveraged loans, while acknowledging that the high-yield bond market is higher quality on a ratings basis than the loan market. “There has been increasing credit risk in the loan market over the last several years and there’s been decreasing credit risk in the high-yield market,” he said.
“Our downside seems to be a little bit more capped assuming we are right on the economic outlook,” he said. “But the volatility is going to be pretty dramatic over the next couple quarters because there does not seem to be a lot of depth of capital currently in the market until you get to a certain spread level.”
BlackRock Inc. (AUM: $8.5 Trillion)
“Now is a reasonable time to allocate money to the asset class,” BlackRock’s Garfin said, adding that prices in the near term could continue to rise. But “there will be opportunities over the next few months or quarters where spreads will widen and you will have a better entry point.”
Garfin doesn’t see a “massive uptick in defaults” in a recessionary scenario given that the high-yield market has moved up in quality over the past several years, companies did a good job at refinancing debt when rates were low and corporate fundamentals are in a strong position. Defaults could rise to 3%-5%.
BlackRock sees opportunities in mid- to high-quality credit, including Bs, BBs and the higher-rated part of the CCC tier. On a sector level, allocation to retail as well as consumer-focused sectors such as travel and leisure should be balanced with sectors with strong stability of cash flows.
Pimco (AUM: $1.8 Trillion)
“High-quality parts of the credit market look attractive for a long-term hold,” said Sonali Pier, high-yield and multi-sector credit portfolio manager at Pacific Investment Management Co. “That said, we do think we’re likely to see a recession.” She sees more spread widening ahead.
“I wouldn’t call a bottom here, but when we can definitively say we’ve seen a bottom we tend to see that the following 12 months have those double-digit high-yield-like returns.”
Leveraged loans have become riskier, she said, as the amount of lower-rated CCC and B rated debt increases. The floating-rate nature of the asset class — which drew in many investors earlier in the year — is a risk to issuers facing rising interest costs.
Nuveen (AUM: $1.1 Trillion)
“We’re definitely at this point, from a credit perspective, pricing in a soft landing, even a mild recession, but not quite a hard landing yet,” according to Nuveen’s Persson.
“Even if we were to drift a little bit higher from a yield perspective, it’s a lot more interesting than we’ve seen in quite some time.”
Persson sees opportunities in higher-rated junk debt such as BB credits, including energy sector debt, adding that there are a number of energy companies in that ratings bucket that could be poised for upgrades into investment grade moving forward. He also sees opportunities in the preferred market.
Apollo Global Management (AUM: $513 Billion)
“There’s a view in the marketplace that the Fed might be behind the curve again, and they’re going to have to start to cut rates at the beginning of next year,” said John Cortese, global head of trading at Apollo Global Management. “That’s why you are seeing rates come in pretty dramatically.”
When spreads went out to 600 basis points and higher, Apollo was actively deploying capital, he said, adding that there’s a lot of money chasing higher-quality credits. “There’s just not a lot of supply in the public markets,” he said.
Cortese believes that the markets are in a good spot in the near-term from a technical perspective, but that it will likely be short lived. “Inflation is real. It’ll be volatile,” he said. “We think you’ll see spreads really start to widen out and stay wider for longer as defaults increase and as companies start to borrow again.”
Aegon Asset Management (AUM: $432 Billion)
“We’ve been constructive on the high-yield market and we continue to be,” said Jim Schaeffer, global head of leveraged finance at Aegon Asset Management.
Even though the economy is in a recession by at least one definition — US gross domestic product has shrunk for two consecutive quarters — Schaeffer is less concerned about the impact of that on the high yield market. “Although defaults will probably increase, we don’t think they’ll increase nearly to levels that we’ve seen in recent periods of time of dislocation or points of inflection.”
The fundamental picture is better, he said, and high-yield issuers did a good job refinancing debt while rates were low. Schaeffer thinks that earnings have not been as bad as markets were expecting but that he will be watching next quarter closely.
Insight Investment (AUM: $880 Billion)
“The marketplace needs to see inflation subside before you can start to see this sort of volatility subside,” said Paul Benson, portfolio manager for Insight Investment.
Earnings have likely peaked, according to Benson, and going to probably start to come down but leverage levels are low and cash levels are strong for high-yield issuers. Liquidity is a challenge for the speculative-grade bond market at this time, he said.
Benson sees continued investment opportunities for potential rising stars and believes that there is going to be more fallen angels credits to invest in in the coming months.
“We’re just not seeing any red flags pop up yet,” he said. “Valuations are starting to look quite attractive.”
Elsewhere in credit markets:
Syndicate desks are projecting $25 billion to $30 billion of high-grade issuance next week and $70 billion to $80 billion for August, after $86 billion priced during that month in 2021.
The volume of litigation asset-backed securities — bonds supported by settlement and verdict payouts in lawsuits — soared to about $533 million in 2021, from $393 million in 2020, according to data compiled by Bloomberg. Those numbers are only expected to keep growing as the number of borrowers seeking funding for legal proceedings increases during trying times.
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Issuance for the week was the equivalent of 5.73 billion euros ($5.82 billion)
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Sales of dollar bonds in Asia tumbled 63% this week as investors awaited the Federal Reserve’s Wednesday decision and issuers saw less urgency to offer debt after the central bank indicated its pace of tightening may slow.
A mild rally in Chinese developers’ dollar bonds appears to be losing momentum, as investors express disappointment that a top leadership meeting failed to unveil stronger policy support for the crisis-ridden industry
The spread between ten-year and three-year Indian corporate notes is on course to widen the most in nearly a year in July as the government’s record borrowing plans weigh on longer-dated bonds
If Evergrande comes up with a restructuring plan by the end-of-July deadline, that will be “quite a milestone” for the China high-yield property bond market as it may serve as a template for other builders’ rehabilitation, according to an analyst at CreditSights
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