Barron’s: High Yield: Hang In Or Bail Out?
December 12, 2015
By AMEY STONE
These are scary times for junk-bond investors. Not only are the bonds falling in price as commodities slump and the Federal Reserve prepares for liftoff, but tax-loss selling and large redemptions in junk-bond funds are dragging down prices further.
Investors saw one of their worst fears realized Thursday when an especially risky, money-losing, high-yield fund facing a wave of redemptions announced it is liquidating. Only by blocking the exits and setting up an orderly process for selling highly illiquid holdings does the Third Avenue Focused Credit Fund stand a chance of returning reasonable amounts of cash to investors.
Friday junk-bond exchange-traded funds, like iShares iBoxx $ High Yield Corporate Bond(ticker: HYG) fell (along with crude oil and equities) an extra-steep 2%, the worst day in more than four years. Year-to-date, the high-yield sector is down some 6%, with 3% of the loss coming in December alone.
Investors who didn’t know what they were getting into when they bought pleasant-sounding high-yield funds, may want to scale back as selling pressures intensify.
Those with long time horizons and risk appetites may find opportunity in select issues. Yields, especially in low, triple-C bonds, are in the high teens. “The opportunity is in the lower-quality paper where there is not a lot of liquidity,” says high-yield analyst Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors. In contrast, prices of bonds just below investment grade have improved in recent months, but they aren’t that cheap, he says.
“I wouldn’t be rushing in,” says Fridson, who expects more mutual fund outflows to pressure the sector following Third Avenue’s “unprecedented” fund liquidation. “You’d have to be awful nimble and maybe lucky to take advantage of these short-term moves.” His model shows the sector will average 3.4% annual returns for the next five years—well below coupon rates. There will be some big price swings within that long-term forecast.
Art DeGaetano, chief investment officer at Bramshill Investments, is among those sniffing for opportunity, but he’s avoiding energy-related names. “We would need to see a fairly decent repricing for us to get involved in some of the sectors that have really started to break down,” he says.
FACT IS, THE HIGH-YIELD sector is not near the bottom. Defaults are rising, but are still below historical averages. Energy issues make up about 15% of the high-yield corporate bond market. The fear is that lower oil will push debt-laden companies into default.
It’s also unclear how the sector will react to the first Fed rate hike in nine years, expected this week. In the past, high yield has done well in the year after the first rate hike, but usually that was in a strengthening economy. Now, mixed recent economic readings make it unclear if the economy is improving or slowing, but the Fed is expected to hike anyway.
There may be a short-term rally in high yield early next year when tax-loss selling abates and after the Fed’s first hike is digested by markets, predicts Strategas Research Partners. But it says that move could be quickly reversed and is “too tactical” for them to recommend that investors jump in.
Gershon Distenfeld, an AllianceBernstein fund manager, believes high-yield makes the most sense as a way to reduce risk in equities, not to reach for yield in the fixed-income side of your portfolio. He says investors shouldn’t overreact to the Third Avenue fund’s blowup—it was much riskier and had suffered deeper losses than the average high-yield fund.
With a dramatic selloff under way, tactical investors may start dipping their toes in icy waters. But most investors should wait for warmer weather. Jim Baird, chief investment advisor at Plante Moran Financial Advisors, isn’t allocating money to high yield. “While spreads have widened, they aren’t wide enough for us to dive in.”