A clever trade executed by several vulture funds in March 2020 was a bet on normalcy. The junk bonds of large, stable companies — think cable-TV and internet providers — had fallen to around 85 cents on the dollar. Knowing that such businesses would have plenty of cash to make interest payments, opportunistic Wall Street readily scooped up that paper, eventually profiting from the rally across risk assets.
That opportunity in the high-yield bond market has presented itself again. According to figures compiled by Citigroup analysts, more than a quarter of high-yield bonds in a major index trade today between 80 and 90 cents on the dollar, the highest such proportion in almost 20 years. One example: 2029 5.25 per cent bonds of Medline, a large private equity-owned maker of basic medical supplies, have traded recently at just 88 cents.
There are several crucial differences between 25 months ago and today. Most notably, the Federal Reserve is commencing a sharp cycle of monetary tightening in response to spiralling inflation. Still, the sell-off in junk bonds has led to implied yields surging to double digits for many companies. For bond buyers willing to hold paper to maturity and clip chunky coupons in the meantime, the temptation is real.
Fixed-income buyers today are fighting two trends. First, benchmarks are rising — the US 10-year Treasury bond yield has eclipsed 3 per cent even as Fed tightening is only getting under way. Second, the high-yield bond spread — the excess that debtholders require to take credit risk — has jumped from 300 basis points to 400bp just this year.
These two forces have been painful for existing holders of junk bonds. The price of the ICE BofA High Yield index is down nearly a tenth in 2022.
While the absolute amount of distressed debt is rising, the figures remain low historically. Major bond investors are calling the end of the 40-year bull market in fixed-income securities. Still, discerning buyers now have a great opportunity in front of them.
The Lex team is interested in hearing more from readers. Do US high-yield bonds have further to fall? Please tell us what you think in the comments section below
