Corporate bond buyers come back with a vengeance
NEW YORK, July 26 (IFR) - Are US fund managers a collection of manic-depressives swinging rapidly from one extreme to the other? A cursory glance of the US corporate bond markets might make you think so.
Just a few weeks after suffering one of the worst sell-offs since the 2008 crisis, investors are back buying bonds as ferociously as they dumped them in June.
So far this month more than US$75bn of high-yield and investment-grade bonds have priced. Negative new-issue concessions are back and deals are attracting as much as 10 times oversubscription and then tightening further in the aftermarket.
Although signs of fatigue started to show in the secondary market last week, Triple C rated borrowers such as industrial compressor manufacturer Gardner Denver still attracted US$5bn of demand and locked in a near-record low 6.875% pricing on its US$575m of LBO.
That is only 50bp away from the lowest ever pricing on an LBO in the US and compares with the 8% area Denver was being told to expect just two weeks ago.
Even financials, which have flooded the market with more than US$40bn of deals in July so far, are luxuriating in an overflow of investor interest. On Thursday Single A rated Travelers Companies priced a US$500m 30-year bond at a negative to flat new-issue concession when two weeks ago, Double A plus rated GE Capital had to pay up 15bp of concession to sell a three-year note.
"Two weeks ago you would have thought that the market had definitely experienced a fundamental change, yet now it doesn't look that way at all," said James Lee, senior high-yield credit strategist at Calvert Asset Management.
"When I saw yields [on the Barclays high-yield index] go to 6.7%, I thought the next move would be 7%, and now we're back down to 5.95%. Who would have thought it?"
After soaring from May 9's record low of 4.99% to June 25's 6.93%, the Barclays composite speculative-grade bond yield has dropped to 5.95%, and looks on track to return to its 5.8% average in the first quarter. The option adjusted spread was at 432bp on Thursday, only 7bp away from the May average of 425bp.
DAMNED EITHER WAY
It's not that fund managers have forgotten what it's like to see their bonds plunge as much as 12 points in price, as some did in June. Rather it is the classic damned if they do and damned if they don't dilemma.
"You have to be involved, whether you like it or not," said Lee. "You can't sit on cash if your competitors are putting their cash to work and outperforming the index more than you are."
After a panicked US$60bn outflow from funds in June, investors poured money back into high-yield and investment-grade bonds in July.
Lipper reported a US$3.28bn inflow into high-yield funds and ETFs in the week ended July 24, the second-largest inflow of all time, trailing only the US$4.25bn and US$3.26bn inflows for the weeks ended October 26 2011 and August 27 2003, and larger than the previous week's US$2.67bn of inflows.
While the high-yield market is clearly the favourite, investment-grade funds are also receiving inflows. Last week about US$1.66bn of new cash poured into the high-grade market.
This is despite the fact that few believe rate volatility is over - most of all issuers and their underwriters.
"A number of sophisticated frequent borrowers have moved quickly to market," said Peter Aherne, head of North American capital markets, syndicate and new products at Citigroup. "I think there is a view that you could just as likely see a reversal in markets as continued improvement."
Volatility around the FOMC meeting and the July non-farm payroll number this coming Friday has been a driving factor behind the rush of FIG deals in the past week.
Some fund managers put faith in past cyclical trends pointing to tighter spreads, as well as the strength of a secular move by the baby-boom generation out of equities and into bonds as they retire. Corporate pension funds are also at high funded rates thanks to the recent strong performance of the equity markets, which is prompting them to derisk their portfolios by selling equities at a profit and buying long-dated bonds.
"I not only think we can get back to the year's tights on spreads but also go through those tights," said Michael Collins, one of Prudential's senior portfolio investment managers.
"I think we will see both high-yield and high-grade corporate bond spreads hit their cyclical lows over the next couple of years," he said. "Look at what's happened with high-yield spreads in just the last few weeks. In all past cycles those spreads have hit 300bp, and we haven't even come close to reaching that level yet, although I expect we will."
Collins expects the same to happen with high-grade corporates, as rising rates bring more yield-sensitive pension fund and insurance companies into the market, driving spreads tighter.
Investment-grade bonds have reached cyclical tights of 60bp-70bp in the past, compared with the 130bp level on the Barclays index recently.
Even bouts of bond volatility are seen as buying opportunities by many investors.
"We've seen new deals tighten in as much as 30bp from initial thoughts to pricing, and if it doesn't make sense at that point, we drop out," said Rajeev Sharma, portfolio manager at First Investors Management Company.
"You might get the opportunity to get back in later, when rates have backed out and the bonds are trading cheaper."
(This story will be published in the July 27 issue of International Financing Review, a Thomson Reuters publication; www.ifre.com)
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