Three Major Asset Managers Buying Junk Bonds as The Prices Fall

Three  articles of note from Barrons fixed income blog indicating some major bond managers are using the selloff to add holdings in high yield (junk) bonds

October 15 on Blackrock

BlackRock‘s fixed income head, Rick Rieder, says the firm has been adding to its high-yield bond holdings during recent days as the 10-year Treasury yield has plunged, capped by this morning’s free-fall that sent the 10-year yield below 2% for the first time since May 2013 before it rebounded to 2.05%.

Calling it “a bit of a crazy day,” Rieder says the rally followed a confluence of disappointing economic indicators, along with renewed worries about the spread of the Ebola viris, and those contributed to an unwinding of popular trades, namely long-dollar trades, shorts aimed at the front end of the Treasury yield curve, and long positions in risk assets, particularly stocks....

Rieder says BlackRock has been adding to its high-yield corporate bond holdings recently. “High yield is actually holding up incredibly well relative to everything else,” he says. “If nominal yield s are going to be persistently lower, led by other parts of the world, then high yield at 6.5% or 6.75% [yields] is not bad compared with a 10-year [Treasury] at 2%.”

Martin Fridson one of the most respected experts in the bond market Octiober 16:

For months, high-yield bond market guru Martin Fridson has been warning about overvaluation, first calling the market “extremely overvalued,” then upgrading that to “way, way overvalued” in May. After the market suffered a brief but intense sell-off in late July, Fridson removed the extreme overvaluation tag, or at least the “extreme” part of that label.

Today Fridson says the market, at long last, is back to being undervalued, or at least “moderately undervalued.” This comes after high yield got pounded amid yesterday’s broadermarket antics, which followed a more prolonged period of weakness.

Fridson, now chief investment officer at wealth management firm Lehmann Livian Fridson Advisors LLC, bases his assessments on his own model for high-yield bond spreads. The market’s average spread has climbed to 508 basis points (yielding 5.08 percentage points more than comparable Treasury bonds) as of the end of the day yesterday from a low of about 340 bps earlier this summer, per a benchmark Bank of America index. 

And October16   on UBS

The high–yield bond market has been suffering lately, and yesterday’s bizarre, wild ride for bonds and stocks alike didn’t do junk bonds any favors, with that market down another 0.55% yesterday, per a benchmark Bank of America Merrill Lynch index. High yield is now down 1.5% over the past week, 2% over the past month and 2.8% since July, trimming year-to-date returns to 2.5%.

Where there’s a rout, there’s a buying opportunity. The average high-yield bond spread over Treasuries has climbed to 508 basis points, meaning junk bonds now yield more than 5 percentage points more than comparable Treasuries. That’s up by 1.6 percentage points from the low spread of about 340 basis points seen in June, when the average junk-bond yield hadfallen to a record-low just under 4.9%. The market’s average yield is up to a much healthier 6.49% today.

Yesterday BlackRock said it’s been buying more junk bonds lately, particularly with high-yield bond yields moving in the opposite direction of plunging Treasury yields. Today UBS Wealth Management says it too is adding to its high-yield holdings,

 Here’s what UBS has to say today:

We believe there has been shift in the relative attractiveness between the equity risk premium and the more defensive credit risk premium, and we add to overweight position in US high yield credit. The recent sell off provides a spread to Treasuries of c. 500bps, or an absolute yield-to-worst of c.6.3%. With the fundamental economic situation in the US still positive, we expect default rates to remain below 2%, allowing for a total expected return of 5-6% over the coming six months, based on our forecasts.

Here is a 10 day price chart of HYG the largest high yield bond ETF

A "Risk Off" Moment in The Markets ?...Are You Sure ?

A standard part of most of the news articles about recent market moves has included the phrase "risk off" indicating investors fleeing from riskier asset classes. Certainly the large gains in price/fall in yields for US  Treasury Bonds fits that description.

But looking at the US stock market the view seems a bit different. Small Cap stocks are considered to be riskier than large cap. This chart shows that US small caps represented by the Russell 2000 (brown line below)  have performed far worse than the large cap S+P 500(SPY). It began its drop already during the first quarter of this year.

Year to Date

Yet here is how the charge looks for the past 5 trading days

5 Days

Looking internationally Emerging markets (etf IEMG) are also considered an asset class sold during "risk off " periods. But here is IEMG(brown) vs SPY ytd and below that the last 5 trading days

Year to Date

5 days

Bond Market Review Third Quarter 2014

The bond markets fluctuated in reaction to anticipation of future interest rate moves but US treasury bonds put in a strong performance in intermediate and longer term maturities. The long term US Treasury bond ETF gained 4.4% in the quarter. The meager yield of under 2.5% looks attractive vs long term European treasury bonds trading at far lower levels which explains part of the strong performance …German ten year govt bonds are yielding .91%.

 This creates a paradoxical situation for investors. A ten year US treasury bond at a yield under 2.5% is hard to see as a good long term investment. Yet traders looking shorter term at global investment opportunities with low European yields and prospects for a weaker Euro could easily drive yields lower and prices higher for US treasury bonds.

High Yield bonds faced a sharp selloff in July recovered, almost all those loses in August and then gave back all of those gains in September. Spreads between high yield bonds and treasury bonds had reached extremely low levels reflecting investors “search for yield”. Those investors likely included many with little experience in the asset class and little appetite for large fluctuations the market in high yield bonds and sold as prices fell. The high yield bond market has far less liquidity than other markets and thus is subject to large swings. This situation was likely aggravated by the changes in management at the world’s largest bond fund Pimco Total Return.

A stronger US economy would mean less rather than more default risk for high yield bonds. That would make the rationale for a sharp decline in high yield bonds relative to Treasury bonds a weak one. But that doesn’t mean momentum won’t continue this trend.

Internationally, emerging markets continued to exhibit high volatility. With the prospects of higher US interest rates in the US, emerging markets would be vulnerable both in terms of bond prices and currency fluctuations. With interest rates at extremely low levels and European Central Bank policies aimed at a lower dollar they are also vulnerable. Much like the US Eurozone bonds have had strong gains of late due to the sharp move down in interest rates. But they would carry a high level of currency risk and little room for capital appreciation looking forward.

As of Sept. 30,2014
Total Return (Price+Dividend)
	ticker	3q 2014	YTD	1 year	3 Year
US total bond market	AGG	4.1%	4.0%	4.1%	7.0%
Short Term High Yield	HYLD	-4.3%	2.1%	13.1%	36.9%
US Long Term Treasury Bonds	TLT	4.1%	16.0%	5.0%	5.0%
International Bonds	BNDX	1.8%	6.0%	-1.1%	5.5%
Emerging Market Bonds(local currency)EMLC	EMLC	-4.9%	1.0%	6.4%	7.2%

Equity Markets Review Third Quarter 2014

Equity markets were extremely volatile during the quarter with daily moves of over 1% not at all uncommon.

The first week of the first quarter (as of this writing October 7) has shown a sharp selloff in global stock markets, sparked by continued disappointing European markets now influencing US and Asian markets as well.

Although the US economic news has been positive valuations remain high. The movements in the bond market continue to waver in their sentiment as to when the Federal Reserve will raise interest rates. And the future direction of interest rates adds another factor of uncertainty to the markets. Thus although the US market reached record highs during the third quarter there has been little follow through.  World Bank economic forecast for 2014 has been revised down a bit to 2.1%

European markets face two negatives: continued weak economic data and the political tensions related to the Ukraine. The European Central Bank has indicated that it will continue policies of low interest rates and a weaker Euro to try to stimulate economies. The overall Euro zone ETF fell 8.8%. Germany reflecting concerns over both political and economic concerns fell even more -11.9% World Bank economic growth forecast in Europe is 1.1%

The impact of the weaker Euro can be seen in the comparison between FEZ and HEDJ which invests in Eurozone stocks but hedges the currency risk fell only 1.6%. Despite the weak economic data from Europe investors should be aware that investing in European stock indices have significant weightings in multinational corporations. Therefore the beaten down European indices have potentially attractive valuations compared to US stocks, particularly if one makes use of currency hedging to protect against a weakening Euro. The valuation discount of German stocks vs. the US is over15% but for the near term pessimism on economic conditions will put a drag on markets.

Emerging markets showed a large divergence which raises the question as to whether investing in emerging markets as an asset class makes sense. The overall emerging markets index was -4%, the index includes Russia. Eastern Europe. Latin America and Emerging Asia. The emerging Asia index by contrast was up .3% and has actually outperformed the US market year to date

Within the emerging markets the outlook for Russia continues to be clouded by political conditions. Latin American growth has slowed considerably and is expected to show economic growth based on the World Bank of only 1.2% from 2.2%. This would be the slowest growth rate since 2009 as a point of comparison the average growth rate from 2003 -2010 was 4.8%.

Asia remains the region with highest forecasted growth despite the fact that the same World Bank report moved down its growth forecast for China down to 7.2% (last year’s growth rate was 7.7% the forecast for East Asia is 6.9%

From the perspective of short and long term economic growth and stock valuation Asia seems the most attractive of international markets. Market prices have yet to fully recover from several years of underperformance vs. US stocks with valuations currently at close to a 30% discount to US markets.

As of Sept. 30,2014
Total Return (Price+Dividend)
	ticker	3q 2014	YTD	1 year	3 Year
US total stock k market	VTI	-0.8%	7.9%	16.6%	92.5%
Emerging Markets	IEMG	-4.0%	5.0%	2.8%	44.0%
Emerging Asia	GMF	0.3%	11.8%	11.1%	62.5%
Eurozone	FEZ	-8.8%	-0.6%	5.2%	44.0%
Germany	ewg	-11.9%	-8.1%	5.0%	69.8%

About Using an Unconstrained Bond Fund

In my last post I wrote that:

 I do certainly hold to the view that "go anywhere" bond funds are not a good idea for investors...certainly not as a significant part of their bond allocation.

A bond allocation should be the anchor of relative stability for a portfolio and should be transparent. 

Jason Zweig in the WSJ weekend edition writes:

Investment-research firm Lipper estimates that 71% of the more than $70 billion in new money that has poured into taxable bond funds over the past 12 months has gone into alternative or nontraditional strategies.

That number will surely rise now that Mr. Gross is joining the Janus unconstrained fund. But a fund can pursue higher returns only by taking on greater risk....

Furthermore, such strategies tend to outperform safer bonds in a bull market—but can suddenly suffer when bonds (or stocks) collapse. Their returns are less bond-like and more like those of the stock market, so these funds are less likely to provide the diversification of conventional bond funds in the next stock-market decline, Ms. Bush says.

The ability to go anywhere, says Mr. Siegel of the CFA Institute Research Foundation, gives unconstrained managers an incentive to take unrestrained risks. “To let bond managers buy whatever they want and not be accountable is kind of crazy,” he says. “A lot of them will just take as much risk as possible.”

About That Pimco Total Return Fund and Investing With the "Bond King"

I wrote about several years ago..I went back and checked the last time and it was June of 2010.

At the time (see below) I argued  that investing in a "go anywhere" bond fund is not a good idea as the core of one's bond holding. A bond allocation should be set according to one's view of the proper distribution among maturity and types of credit risk (govt, investment grade and high yield) and for some international...although I am not a fan of international (non US) bonds. This can be easily done with full transparency through a mix of bond ETFs. In fact one approach although not one I favor is simply to buy a total US bond market ETF like AGG or a fund like the Vanguard Total Bond Index.


 Investing in a go anywhere bond fund is simply investing with a "genius" akin to giving money to a hedge fund manager and in fact at times Pimco Total Retund Bond Fund derivatives, emerging market bonds, bank loans preferred stock along with more traditional holdings like US Treasury As the FT reported:

Total Return is spread across the fixed income universe and many of its holdings are huge in proportion to the markets in which it trades. Close to 10 per cent of it, as of March, was in Spanish and Italian government debt, and it has a big position in the relatively illiquid index-linked Tips market. Further, because of its size, it has had to make many bets via derivatives, taking on exposure to Indonesian or Chinese credits using credit default swaps. The section on derivative positions in its latest annual report runs to 26 pages.


I am not much of a believer that there are market "geniuses' and if there are the streak is bound to end and even if one believes in such geniuses such an investment should be a small part of ones portfolio not a core holding.

So perhaps the question investors who have held Pimco Total Return Fund particularly if it is a major part of their bond allocation are asking the wrong question. It seems many are trying to decide whether it is time to stay with PIMCO, move to Janus and follow Bill Gross or search for the new "bond king". In fact the WSJ has a 6 minute video on this subject .if you google that topic you will get at least a half dozen similar articles.

Perhaps the better question investors should be asking is if this isn't a good opportunity to replace that "go anywhere bond fund" with bond ETF(s) or index fund(s)

There are No Geniuses ....Bond Market Division

I have written before about the largest actively managed bond mutual fund in the world: Pimco Total Return. Although the firm and many analysts categorize it as a "core" bond holding I argue that since it can literally move anywhere in the realm of fixed income it is more of a bet in its manager "bond guru" Bill Gross. The investor in the fund never really knows what Pimco Total Return is holding and the market view and hence allocation of the manager can change radically. While Mr. Gross may indeed be a very bright man a core bond holding, as I have argued before, should consist of an etf or index fund where when knows exactly the maturity and credit quality of the holdings at all time.

I certainly had no advance knowledgeof what would happen to Mr. Gross and his fund.

But I do certainly hold to the view that "go anywhere" bond funds are not a good idea for investors...certainly not as a significant part of their bond allocation.

A bond allocation should be the anchor of relative stability for a portfolio and should be transparent. 

WSJ on Divergence Among Emerging Market Economies

I wrote a blog last week on the divergences among emerging markets . WSJ has an article about the subject  today:  I pointed out  the fragile five countries Turkey, Brazil, India, South Africa and Indonesia as having the most potential for underperformance.

From the WSJ:'