As many of you have seen or heard, high yield bonds have suffered enormous price declines over the last three days. Concerns about increasing interest rates and crashing oil prices have led investors in droves to redeem high yield mutual funds and sell high yield ETFs. A mutual fund managed by Third Avenue Management and the Stone Lion Capital Partners hedge fund have stopped returning capital as the market-proxy SPDR Barclays High Yield Bond ETF closed yesterday at its lowest level since 2009. Liquidity is lacking and there are fears of credit contagion.
Since the crisis in 2008, income-starved investors–who would never have bought junk bonds before–responded to near-zero interest rates and massive quantitative easing by scooping up high yield debt in record volumes. Issuers predictably obliged that demand with record issuance at historically low rates and favorable spreads to US Treasuries. The dynamic we’re observing this week is an inevitable and volatile reversion to a more stable equilibrium. As we often say at Greycourt, “nothing good lasts forever.”
Over the last two years, we have spotlighted many of the changes emerging in credit markets, highlighting liquidity issues in the Greycourt white paper linked below, especially in complex credit and some energy high yield sectors. We also responded to these changes by avoiding new investments in several credit-oriented sectors and strategies; recommending significant reductions in nearly all liquid high yield, bank loan, and other credit-sensitive strategies; and underwriting potential new investments at significantly increased discount rates.
Prospectively, shattered prices and wide price dispersions across credit investments and within sectors will create opportunities for skilled and patient investors. As a result, we’re identifying new investments in opportunistic credit, mostly in hedge format, especially focusing on managers with robust opportunity and skill sets. We continue to carefully evaluate existing positions and will make new recommendations when market conditions are more opportune. As we also often say at Greycourt, “nothing bad lasts forever,” either.