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U.S. Junk bond yield-to-worst drops below 5 percent for first time
May 8, 2013 / 3:26 PM / 5 years ago

U.S. Junk bond yield-to-worst drops below 5 percent for first time

NEW YORK, May 8 (IFR) - Junk bond yields have fallen below 5% for the first time ever, as investors scrambling to get the biggest return possible have pushed the market into record territory.

A trader works on the floor at the New York Stock Exchange, April 16, 2013. REUTERS/Brendan McDermid

The yield-to-worst on the Barclays US Corporate High Yield Index closed Tuesday at 4.97%, breaking through the 5% barrier for the first time in the index’s 30-year history.

The market has been driven by roaring demand from investors, along with massive bond purchases by central banks trying to prop up an uncertain global economy.

“Investors in general are pretty desperate for yield and there’s been a lot of money pouring into the market,” said Michael Collins, senior investment officer at Prudential Financial.

Yield-to-worst is the lowest possible yield on a bond without the issuer defaulting. Barclays calculates the figure based on the yield-to-worst of all the bonds in its index.

As the Federal Reserve keeps interest rates at record lows, returns on bonds remain low as well - sending investors chasing after ever-riskier assets to maximize their returns.

But that surge of demand has steadily driven down the returns, or yield, over the past few months. Bond prices and yields move in opposite directions.

Just three months ago, the yield-to-worst was 6%; at this time last year, it was 7%.

“There’s nowhere to turn right now where investors should have an expectation that their forward return is going to be greater than the historic average for that asset class,” said Michael Kessler, a credit strategist at Barclays.

The Fed last week confirmed it will stick to its policy of low rates and continued bond buying for the time being, meaning that returns across bond classes will be kept in check.

US Treasuries returned just 0.70% through the end of April, and bond yields - which typically move in parallel with Treasury rates - have also been limited.

The Barclays US Investment Grade Credit Index, which tracks high-grade rather than junk bonds, returned 1.63% over the same period.

At those low rates of return, many bond investors have been moving down the ladder of credit quality into high-yield or so-called junk bonds to increase their return.

The Barclays high-yield index produced an average return of 4.75% in the first four months of the year. (This is still much lower than US stocks. The Dow is up 14.9% on the year, with the S&P 500 up 14.0%.)

Afraid of missing out on the increasingly meager returns on offer, those investors who can - many institutional investors are banned from buying junk-rated securities - have been pouring money into the high-yield sector.

Investors injected another $474 million into high-yield mutual and exchange-traded funds in the week ending May 1, according to data from Lipper, a Thomson Reuters research firm.

That was the sixth net inflow for high-yield funds in seven weeks, and took total inflows to more than $2 billion for the year.

But many analysts say the headlong rush into junk bonds - riskier debt from companies with significant weaker credit profiles - will spell trouble in the not too distant future.

The same central bank policy that is supporting bonds now is intended to jump-start economic growth. And when significant growth does return, the riskiest assets will be sold off.

“We anticipate that unwind for credit will come into that much needed recovery in growth, which we think has the potential to unleash a fairly savage structural repricing in credit,” said Suki Mann, head of credit strategy at Societe Generale.

Still, even with yields so low, spreads still offer enough cushion to protect investors if Treasury yields back up. According to Barclays, the option adjusted spread of 406 basis points is still far wider than the historic tight of 233 bps reached on May 23, 2007.

But analysts at Bank of America Merrill Lynch this week said a survey of investors found increasing worry that the rush into high-yield is driving down yields without a corresponding change in credit fundamentals or interest rates - signs of what could be a classic investment bubble.

“There are increasing concerns about inflows leading to bubbles, mainly in high yield,” the analysts said.

“In fact, asset bubbles now rank as the number one concern on credit investors’ minds.” /

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