Wednesday, April 11, 2012

Gunning for yield and "quality" leaves little room for error

The global high yield bond issuance hit a record during the past quarter. With persistently low rates and tremendous demand for yield from mutual funds and ETFs, companies lined up to get ridiculously cheap financing.

Source: Credit Suisse

The chase for junk bonds however has been uneven. In the current environment investors want to make sure that companies have enough of an earnings cushion to withstand another shock. The demand for very high leverage companies has been weaker relative to the rest of the junk bond market. While the CCC issuance has been below previous years and below its weight in the HY index, the BB issuance was materially higher. Buyers have been looking for lower leverage (higher quality) companies that would survive a sharp increase in the debt to earnings ratio.

Source: Credit Suisse

This shift into "quality" resulted in lower yields for new issue BBs while higher yield for CCCs.

Source: Credit Suisse
This tells us that we continue to have strong demand for yield combined with concerns about "tail risk". But chasing new issue BB bonds yielding 6.3% could be a mistake. There is little upside on such bonds with treasury yields already at historical lows and spreads at fairly tight levels. Buying bonds like these simply leaves little room for error.

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