* Summer sell-off throws up bargains, say managers
* Funds eye high yield, senior secured, short duration
* Avoca shorted Lloyds CoCos, now a holder
By Laurence Fletcher
LONDON, Oct 21 Opportunistic hedge funds are
picking up bargains in corporate bonds after a sharp sell-off
this summer, preferring the sector to pricey-looking government
A number of managers believe credit markets are now pricing
in too-deep an economic slowdown and default rates that are too
high, and are picking up high-yield bonds in the United States
and Europe, often favouring short maturities, as well as senior
"Credit offers a very good risk-reward, especially after the
last few weeks," said Omar Kodmani, president of fund of funds
firm Permal Group, which runs $21 billion in assets. "High yield
is very attractive in our view."
The average spread of high-yield bonds over government debt
has rocketed from less than 500 basis points in May to 1049bp
earlier this month, according to Bank of America Merrill Lynch,
as investors cut positions amid fears over the extent of
Europe's debt crisis.
That rise took spreads within sight of the 1,134bp hit in
August 2009, just as the European high-yield boom got underway,
although they have since fallen back to 877 basis points, helped
by renewed hopes euro zone politicians can resolve the crisis.
Permal's Kodmani said he is raising exposure to credit hedge
funds by around 10 percentage points across the group's
portfolios, attracted by a sell-off in U.S. high-yield he
describes as "indiscriminate".
"In the U.S. one-quarter of high-yield securities trade on a
yield of more than 10 percent," he said. "The overall spread
level is pricing in very high default rates of 8 percent, and we
don't see that materialising given our views that the U.S. will
He said he sees opportunities in non-agency residential
mortgages. "A lot of paper is pricing in further falls in house
prices, but in some areas you have good housing market
Traditional fixed income investors are also moving back into
the high yield market.
M&G Investments, which manages more than 108 billion pounds
of fixed income assets, said last month its institutional funds
are buying high yield bonds for the first time since the credit
crunch, enticed by a yield pick-up of 5.5 percent over
investment grade paper.
Patrick Armstrong, joint managing partner at Armstrong
Investment Managers, which runs around 250 million pounds ($390
million), said yields on corporate bonds look attractive
compared with sovereign debt.
German 10-year bond yields , for instance, are
currently less than 2.1 percent, having traded below 1.8 percent
earlier this month.
"Credit spreads ... are now at levels that have historically
been seen only in recession," he told Reuters. "We are attracted
to the higher yield as an alternative to government bonds, which
are yielding significantly below levels of current inflation."
He particularly likes bonds with short maturities, given the
uncertain long-term outlook.
"A short duration profile protects against a worsening
longer-term credit environment and from potentially higher
interest rates in general, while still providing a yield
significantly above current levels of inflation," he added.
Meanwhile, Simon Thorp, who runs $130 million in hedge
fund-style credit funds at Avoca Capital, also favours
He had sold bonds in some cyclical sectors in May and June
but has recently begun buying back into senior secured bonds in
sectors such as healthcare and telecoms after the sell-off.
"Selling of these credits has taken place because they are
more liquid names, yet most continue to do well, and as an
investor one is protected because of the seniority of the bonds
and the security package," he said.
"Senior secured paper with short maturities to run (under 18
months) look especially attractive, where the key calculations
are around short-term liquidity rather than how the business is
likely to be performing in two-to-three years' time."
However, Thorp has also found short-selling opportunities,
amongst some senior unsecured bonds whose spreads traded close
to secured bonds, and in consumer-facing areas such as retail
and food as he argues margins are coming under pressure.
He has also shorted Lloyds' contingent convertible bonds
(CoCos) -- bonds that boost capital by converting into equity if
a bank runs into trouble -- but has now actually bought into the
bonds after the summer sell-off.
"We felt that a number of investors who held the paper would
be shaken out if there was a market sell-off and yields on the
paper were sub 8 percent. Now that the market has backed up we
have turned the position around, going long at yields between 12
and 13 percent."