Loomis Sayles, GAM, and Standish are among those who say U.S.
investment grade and high yield corporate bond prices have gone too
far, making returns less compelling. They're aiming to get ahead of
a market reversal that could be unpleasant once the Fed starts
raising interest rates, probably next year.
"Valuations are getting stretched," said Jack Flaherty, investment
manager at GAM, part of GAM Holding AG, a publicly-listed Swiss
company with more than $120 billion in assets. "You'd rather be
early in getting out because when it does turn, it could be more
violent than expected."
Bonds had a solid start to 2014, with the Barclays U.S. Aggregate
Index returning about 3.8 percent for the first six months of the
year. Interest from overseas investors and pensions has kept flows
into fixed income funds strong.
That has reduced the extra premium investors are willing to pay to
hold these bonds instead of the safer U.S. Treasuries. This premium,
or spread, is now at its lowest since 2007, and suggests confidence
in the prospects of the U.S. corporation issuing the debt.
GAM has pared its U.S. high-yield bond holdings, and plans to cut
back more over the next few months. It's re-allocated to emerging
market local debt and convertible bonds -- debt that can be
converted into shares of stock.
Flaherty is concerned that after the Fed raises rates, liquidity
could be a big problem because of Wall Street brokerages' reduced
presence in the corporate bond market.
In the past, big banks could be counted on to make it easier to buy
and sell bonds because of their sizable inventory. But new rules
have made it more costly to hold such assets.
The premium investors demand to hold U.S. high yield debt was about
353 basis points as of Monday, according to Bank of America-Merrill
Lynch data. That premium is much lower than the fair value estimate
of 551 basis points put out by Marty Fridson, one of Wall Street's
high yield experts who's now chief investment officer at Lehmann,
Livian, Fridson Advisors in New York.
The spread between U.S. investment grade and U.S. Treasuries was 109
The yield on a U.S. high-yield bond fell to 4.8 percent, the lowest
ever for this asset class, although on Monday, the yield has climbed
to 5.28 percent. In the case of U.S. investment grade bonds, the
yield was about 2.97 percent.
"The longer the Fed goes on, the more disruptive it would feel like
when it ends," said David Horsfall, co-deputy chief investment
officer at Standish Mellon Asset Management in Boston. The firm
oversees $160 billion in fixed-income assets.
"When the Fed raises rates on the short end, that would almost
always cause a disruption. It has to, because rates have been so
Horsfall said the firm's U.S. investment grade holdings at one point
were as much as 60 percent of its portfolio, and now has been
reduced to 5 to 6 percent. For U.S. high-yield bonds, Standish held
as much as 40 percent, but has cut that to 8 to 10 percent.
Standish has instead re-allocated to New Zealand and Australian
bonds, as well as U.S. Treasury Inflation-Protected Securities
(TIPS), which rally if inflation rises.
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Prudential Fixed Income, with about $418 billion of assets under
management, has also reduced its risk the past month, said Gregory
Peters, managing director and senior investment officer. The firm
has sold high-yield bonds that have fundamentals they're not
comfortable with, he said.
"You want to be more careful from a credit perspective," said
Peters. "The market is not going to reward bad credit stories this
late in the cycle."
Prominent investor Dan Fuss said his $24.4 billion Loomis Sayles
Bond Fund is sitting on more than 25 percent of short-term U.S. and
short-term Canadian government debt, cash and cash equivalents, its
highest level ever, because he sees scant opportunities in the bond
Fuss, vice chairman and portfolio manager at Loomis Sayles, which
oversaw $210 billion as of March 31, said the Loomis Sayles Bond
Fund has been moving into these areas since early 2013 as bonds have
become increasingly pricey.
ROBUST BOND INFLOWS
U.S. corporate bond inflows have been strong, boosted by the
prospect of higher yields than U.S. Treasuries without the risk of
So far in 2014, U.S. high-yield funds have seen a net inflow of $7.1
billion, Lipper data show, reversing outflows of $5 billion in 2013.
For U.S. investment grade, inflows were $43.7 billion this year,
compared with $33.8 billion a year ago.
With volatility low, a selloff seems unlikely now, said Lehmann's
Fridson. "The Fed will not raise interest rates until 2015. So until
then, investors don't have to worry about it."
Some money managers have argued that despite the decline in spreads,
there is room for further contraction. Mary Kane, portfolio manager
and a partner at GW&K in Boston, believes there is a further
100-point narrowing in U.S. high-yield and 50-point contraction in
U.S. investment grade.
"It's a game of relativity. In a world of zero percent, 5 percent
yield (on junk bonds) is pretty good," said Kane, whose firm has
about $20 billion in assets under supervision.
Decent returns are still possible in the corporate bond space, said
GAM's Flaherty. "And when that's over, people say they can get out
in time. But can they really get out when everybody is at the door?"
(Additional reporting by Jennifer Ablan; Editing by David Gaffen and
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