Junk bond fever building as high grade trails

Intelsat, Valeant

While high-yield debt has gained back more than half its 2.8% decline in June, investment-grade bonds have recouped less than a third of their return and have lost 1.2% since year-end.

High-yield bonds are graded below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

Bonds of Intelsat, the largest issuer of high-yield bonds in the U.S. this year, have gained 3.99% this month, the most among the biggest 50 borrowers in the Bank of America Merrill Lynch Global High Yield Index. Valeant Pharmaceuticals International Inc., the Laval, Quebec-based drug distributor acquiring Bausch & Lomb Holdings Inc., returned 3.88%.

Relative yields on high-yield bonds globally were 511 basis points on July 26 compared with the all-time low of 233 in June 2007, Bank of America Merrill Lynch index data show. Spreads on investment-grade notes of 150 basis points are up from this year’s low of 132 on May 28.

More Volatility

Luke Hickmore, an investment director at Scottish Widows Investment Partnership in Edinburgh, said his firm favors junk bonds over higher-rated debt.

“The difference between the absolute yield you get in high yield versus investment grade will grind tighter as slowing stimulus becomes a reality,” he said.

More volatility may be in the offing if the economy shows signs of improvement, flaring concern that the Fed will slow its bond purchases faster which would send yields soaring. Payrolls climbed by 202,000 a month on average from January through June, up from 180,000 in the second half of 2012, Labor Department figures show.

“We’ve been bearish on high yield for several months,” said Andrew Rabinowitz, a partner and chief operating officer of Marathon Asset Management LP, a hedge-fund firm that oversees more than $10.5 billion. “We’re still skeptics of it. It’s a yield play.”

Default Rate

Median leverage for high-yield companies has risen to 3.92 times from 3.42 times at the end of 2011, according to a June 3 report by Morgan Stanley strategists led by Richmond. Borrowers have sold $305.5 billion of speculative-grade bonds this year globally, more than the $206.5 billion issued in the same period last year, Bloomberg data show.

RBS strategists forecast that high-yield bonds will return 8.3% in 2013, compared with a 0.6% gain for investment-grade notes, Kamford said.

The 12-month trailing global speculative-grade default rate fell to 2.8% at the end of the second quarter from 3.1% in the same period last year, Moody’s said July 11. The ratings firm expects the rate to rise to 3.2% by year- end.

“Default rates are close to historic lows and are expected to stay that way for the foreseeable future,” Kamford said. “We prefer high yield versus investment grade due to the extra coupon cushion it provides.”


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