Home' Trinidad and Tobago Guardian : August 17th 2014 Contents SBG12 FINANCE
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt AUGUST 17 • 2014
The stock market isn t the only
place that s been signaling jit-
ters among investors. The
US$2.3 trillion market for risky
US corporate debt has also
been under pressure.
A five-year rally in junk bonds abruptly
stalled last month. As with other higher-risk
investments, investors have pulled back mainly
because they worry about the end of the Federal
Reserve s policy of near-zero interest rates.
Investors expect the central bank to raise rates
sometime next year, and that means the value
of bonds currently held in portfolios will fall.
Junk, or high-yield, bonds are sold by com-
panies with relatively high debt in comparison
to their income. If yields on safer bonds like
Treasurys were to climb, they would draw
more investor interest. Companies selling junk
bonds would then have to increase their yields
to compensate investors for the higher risk.
Doing so would diminish the value of junk
bonds currently in circulation.
In July, those concerns hit the market, leaving
junk bond investors with a 1.3 per cent loss
for the month. It was the worst monthly per-
formance since June 2013.
Junk-bond yields have fallen so far that
many investors now feel the risks outweigh
the potential return. Five years ago, the average
junk bond yielded 11.5 per cent. By June, the
yield had dropped to a record low of 4.83 per
cent, according to data from the investment
As a result, investment advisers have become
less enthusiastic about recommending junk
bonds to clients.
There is often some role for high-yield bonds
in investors portfolios, but "there s a time to
dial it up, and a time to dial it down," says
Darrell Cronk, deputy chief investment officer
at Wells Fargo Wealth Management. "Now is
a time to dial it down."
Cronk says junk bonds may continue to
slump as the economy improves and investors
push up Treasury yields in anticipation of the
Fed nearing its first interest rate increase since
"The risk-reward trade-off is not that attrac-
tive anymore," says Collin Martin, senior fixed-
income research analyst with the Schwab Cen-
ter for Financial Research. "We just don t think
that investors are being compensated for the
risks involved in high-yield bond investing."
The market for risky bonds has become
more mainstream since the 1980s, when trad-
ing was dominated by Michael Milken, the
junk-bond financier, and his now-defunct
firm Drexel Burnham Lambert. In those days,
the market made headlines for helping fund
takeovers of companies such as RJR Nabisco.
Milken s reign as the king of junk bonds ended
in 1989, when he pleaded guilty to securities
fraud, defrauding a mutual fund and other
Investors plowed US$55.01 billion into junk
bond mutual funds last year, more than double
the US$22.1 billion total for 2009, according
to data from the Investment Company Insti-
tute. Signs now suggest that investors have
started pulling back. As the high-yield market
started to wobble in June, investors withdrew
US$4.9 billion, according to the most recent
data from ICI.
The recent outflows came as Fed Chair Janet
Yellen said that she was concerned that
investors were becoming complacent about
the risks of investing in high-yield bonds.
Yellen told reporters in June that the market
was showing evidence of "reach-for-yield"
behavior, when investors focus on return irre-
spective of risk. One sign of this behavior is
the fact that investors have been demanding
less of a premium to hold high-yield debt
compared to high-quality government debt.
At the start of 2012, investors received a
yield premium of 6.99 per cent over Treasury
notes, which are widely considered to be risk-
free. By June, that cushion had fallen to 3.23
Some investors say that the fall in junk-
bond yields is justified because the risk of
companies defaulting on their debt has
Company executives have taken a more cau-
tious approach to managing their businesses,
says James Keenan, a managing director at
fund manager BlackRock, who oversees the
company s corporate bond business. Instead
of spending money on expansion, they re
focused more on paring debt. Many companies
have used the proceeds from bond sales to
refinance their existing debt at lower rates.
"We re in an overall pretty healthy economic
environment, and most of these corporations
have pretty stable balance sheets," Keenan
The number of companies defaulting on
their debt has fallen significantly since the
Great Recession ended in June 2009. That
year, 195 US companies defaulted on US$516.1
billion of debt, according to data from the rat-
ings company Standard & Poor s. By 2013, the
total had dropped to 45 companies defaulting
on just US$64.9 billion.
Investors should see the recent sell-off as
an opportunity to buy, providing that defaults
remain low, suggests Gershon Distenfeld, direc-
tor of high-yield debt securities for Alliance-
Bernstein. Since the sell-off, the average yield
on junk bonds has climbed from the record
low it reached in June to 5.64 per cent.
At the same time, investors should also
expect lower returns. Junk bonds have delivered
a sizzling average annual return, including
interest payments, of 12.6 per cent over the
past six years, according to data from Barclays.
By comparison, the Standard & Poor s 500
index has returned 9.7 per cent annually,
including reinvested dividend payments, over
the same period. In coming years, Distenfeld
foresees returns averaging between 5 and 7
per cent for high-yield bonds.
"Unless you can time it really well, you re
going to be better off having stayed in the
marketplace, as long as you recognise that
you re going to have more modest returns
than you once had," Distenfeld says. AP
In this June 18, 2014 file photo, a television monitor at a trading post on the floor of the New York Stock Exchange shows the decision of the Federal Reserve. Like with other higher-risk
investments, investors have pulled back from junk, or high yield, bonds because they worry about the end of the Federal Reserve's policy near-zero interest rates. Investors expect the central
bank to raise rates sometime next year, and that means the value of bonds currently held in portfolios will fall. AP
Like stocks, junk
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