The high-yield market has been beat up a lot this year, and it took a large hit last week when the Third Avenue Focused Credit fund halted redemptions.
“This received an incredible amount of media coverage, and in many cases investors were led to believe this was a broad problem within the general high-yield market,” says Nicholas Leach, vice-president of global fixed income and high yield at CIBC Asset Management, and lead manager of the Renaissance High-Yield Bond Fund.
But, “that is simply not the case.”
He explains the Third Avenue fund was invested in the riskiest part of the high-yield market. “Many of [Third Avenue’s] remaining top holdings are distressed debt and bankrupt companies,” Leach says. “Many of these investments are simply bankruptcy claims: they’re no longer considered bonds, they’re no longer paying coupons, they’re no longer rated, and, as such, they’re now no longer included in any of the high-yield indices. The ETFs don’t even hold them.”
The kicker? “Arguably, these investments are not part of the high-yield market at all.”
Despite that being the case, “the reaction among retail investors was panic, driven by the fear that more high-yield mutual funds were going to introduce more restrictions and halt more redemptions.”
He also blames the mainstream media for stoking fears. “We’ve seen news reports [saying] that as of early December, high-yield ETFs have lost as much as 12% year to date.” He cautions that was “the price decline only, and it doesn’t include the coupon—the primary reason for investing in these bonds. The actual declines are closer to 6% when that coupon is included.”
Another story decried the illiquidity and lack of pricing transparency of the high-yield market, but Leach says these worries are unfounded. “This is not true. Virtually all U.S.-dollar trades are reported to FINRA, the Financial Industry Regulatory Authority. All trades are available to the public on Finra.org, [which] includes the number of trades and the prices.”
Time to seize opportunities
Leach says fear, not fundamentals, is driving many high-yield outflows. “We’re seeing negative pricing pressure, even on the highest-quality area of the market. […] Managers are being forced to sell in order to raise cash to meet redemptions.”
That means it’s time to buy, especially because he’s seeing rare opportunities. “For example, we’re seeing price weaknesses in HCA, which is the largest hospital operator in the U.S. We’re seeing weakness in Restaurant Brands International, which is also known as the Tim Hortons-Burger King credit.”
Even better, he says, “we are not seeing problems in liquidity for the majority of the high-yield space. In fact, high-yield bond trading volumes reported by FINRA are actually slightly higher than [levels seen] a year ago; it’s just that the prices are a little bit lower.”
Protect against the riskiest issues
The triple-C market, the lowest-rated part, takes up about 12% of the entire high-yield market.
But, truly distressed bonds are issued by companies that have already filed for bankruptcy under Chapter 11 in the U.S. or the Companies’ Creditors Arrangement Act in Canada. And, those issues aren’t included in the definition of the high-yield market, says Leach. “The conventional […] indices don’t include bankrupt companies because they don’t pay a coupon and don’t have a maturity date.”
Leach avoids bankrupt and Triple-C issues, and has removed them from his benchmark. “What it really does is it removes the temptation for a manager to venture down into the types of investments such as those that could be found in the Third Avenue fund, and those companies that have attracted a lot of negative media recently.”