26 April 2017

Investors Venture into Junk Bonds

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With Federal Reserve keeping short-term interest rates near zero, investors say they have no choice but to seek ever-riskier securities to generate any type of return. That means almost any borrower is able to sell bonds with few questions asked.

The value of bonds tracked by the Bank of America Merrill Lynch Global High Yield Index has soared to more than $2 trillion. It took 12 years for the index, started at the end of 1997, to reach $1 trillion, and only four years to add another trillion. More than $350 billion of high-yield debt has been sold this year, putting 2014 on track to top last year’s record $477 billion.

So far, investors have been rewarded: Junk-bond investors have enjoyed a total return of 157 percent, better than the 122 percent for the MSCI All Country World Index of Stocks, since the depths of the 2008 financial crisis as measured by Bank of America Merrill Lynch indexes.

Investors are eager for high-yield debt that borrowers increasingly are dictating their own terms. Moody’s Covenant Quality Index for junk bonds, which tracks the strength of investor protections in high-yield bond contracts, is at almost its weakest level since it was created in 2011. For the first time, more than half of the junk-rated loans made in the U.S. are “covenant-light,” meaning they lack typical lender safeguards such as limits on the amount of debt a borrower can amass relative to its earnings.

Investors are relaxed because central banks are doing so much to support the market. The Fed has injected more than $3 trillion into the global economy through its bond purchase programs. Central banks’ largesse means that borrowers who otherwise would have defaulted have been able to refinance and extend maturities, giving lenders few reasons to worry. The global junk-rated corporate default rate fell to 2.2 percent in June. The company sees the rate finishing the year at 2 percent, well below the historical average of 4.7 percent.

While keeping rates low, central bankers have started to say they’re worried that investors are too complacent, increasing chances for future market instability. Junk-rated borrowers have $737 billion of debt due in the next five years, peaking in 2018. That prospect hasn’t deterred investors, who keep paying higher prices for risky debt, driving yields down (yields fall as prices rise). Since peaking at 23.2 percent at the end of 2008 during the financial crisis, average junk-bond yields tumbled to a record-low 5.6 percent last month.

Click here to access the full article on Bloomberg.

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