NEW YORK (Reuters) – Cracks have been surfacing in the junk bond market.
Returns on leading high-yield indexes are down and cash outflows are rising, as are short interest bets against the asset class. In addition, investor protections have shown signs of improvement, suggesting junk bond issuers are being forced to offer better terms to attract interest.
Valuations - Aggregate - Greg - Peters - Portfolio
“Valuations are, in aggregate, stretched,” Greg Peters, senior portfolio manager at PGIM Fixed Income, which has $709 billion in assets, said on Monday. “We have definitely taken down our overall risk profile.”
Bargaining power has long been in the hands of junk-bond issuers, which have been one of the biggest beneficiaries of ultra-low rates set by the Federal Reserve.
Junk - Bonds - Securities - Ba - Moody
Junk bonds are non-investment grade securities, rated Ba or below by Moody’s Investor Service. The lower the rating, the greater the default risk. Some investors like them because in today’s market there are not a lot of options for finding yield.
Since 2011, investor protections, called covenants, have been deteriorating, according to the Moody’s Covenant Quality Index (CQI). And yet, investors’ insatiable appetite for yield has led them to high-yield bonds, where the average spread of those bonds collapsed to a new low of 331 basis points over U.S. Treasuries in late January, according to ICE Bank of America Merrill Lynch data. That collapse was bad for junk bond investors because the yield on bonds is now much lower, but it did provide a short-term benefit for those who were already holding junk because prices rose.
Situation - Investor - Protections
The situation on investor protections has been changing, however.
With the Fed projected to raise interest rates at least three times this year as inflationary pressures brew, investors are demanding better premiums and covenant protections to hold speculative-rated corporate bonds.
Yield - ICE - BAML - Index - US
The yield on the ICE BAML index that tracks U.S. junk bonds rose 28 basis points...
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