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 Through September, corporate bond portfolios boosted their holdings
of U.S. government debt by 15 percent, compared with a 6.5 percent
increase in corporate bonds during the same period, according to
Lipper Inc data. The funds now hold about $13 billion in Treasuries,
15 percent more than the $11.3 billion they held at the end of 2013.
Corporate bond funds typically invest in a range of debt that
includes mortgage-backed securities, U.S. Treasuries and bonds
backed by student loans, credit cards and auto loans. Some corporate
junk bond funds have guidelines that allow them to buy individual
stocks. The move to buy Treasuries, which are more easily traded
than most corporate bonds, show that managers anticipate market
turmoil that could lead to redemption demands from investors.
Matt Toms, head of fixed income at New York-based Voya Investment
Management, said he has cut exposure to corporate bonds in favor of
mortgage-backed securities, for example. In particular, he has
reduced corporate debt issued by U.S. financial companies because of
their exposure to the weak European economy. He sees mortgage-backed
bonds as more U.S.-centric because they are backed by the ability of
American homeowners to make good on their monthly mortgage payments.
"The volatility in Europe could translate more quickly through the
corporate debt issued by U.S. banks," Toms said.
A year ago, the Voya Intermediate Bond Fund's top 10 holdings
included debt issued by Morgan Stanley, JPMorgan Chase & Co and
Goldman Sachs. But more recently, none of those banks' debt cracked
the top 10 holdings of the fund, disclosures show.
Toms, who runs the $1.9 billion Voya Intermediate Bond Fund, said
nearly two-thirds of the portfolio's assets are in government bonds
or government-related securities.
"That's a highly liquid pool," he said.
Michael Salm, co-head of about $60 billion in fixed-income assets at
Putnam Investments, said slumping energy prices could also increase
the rate of corporate defaults among junk-rated energy companies. He
also said he sees subtle deterioration on the balance sheets of
corporations outside the financial sector. He didn't talk about any
specific energy companies on the cusp of default and said company
policy prohibits him from talking about individual securities.
"They're starting to use leverage more, they're starting to do
things that are less bondholder-friendly," said Salm, whose $1.7
billion Putnam Income Fund generated a 6.88 percent return during
the 1-year period that ended Sept. 30. That was fifth best among
core bond funds, according to Lipper.
Some corporations have been issuing new debt to repurchase more of
their own stock, which is viewed as a negative for bondholders. In
June Fitch downgraded Monsanto's issuer default rating to "A-" from
"A" after the company announced a new two year $10 billion share
repurchase program. Bond fund managers would rather see the money be
invested in activities that boost cash flow and growth, for example.
To be sure, the average amount of corporate debt in corporate bond
funds rose to 52 percent of current assets from 48.6 percent at the
end of last year, according to Lipper, Inc, a unit of Thomson
Reuters.
LIQUIDITY A WORRY
One trouble is that it's become harder than ever to buy and sell
corporate bonds in the secondary market as new regulations and
capital requirements since the financial crisis forced Wall Street
banks to slash their inventories. That has left a vacuum in matching
buyers and sellers, and bond managers say they don't want to get
caught holding too much of it in a rout.
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"Everyone sees the lack of liquidity as a potential risk in the
corporate bond market," said Sumit Desai, the lead analyst for
corporate credit funds at research firm Morningstar Inc. "But there
hasn't been a major event to test the market."
The value of corporate bonds held by U.S. mutual funds has more than
doubled since 2007 to about $1.7 trillion. Corporate bond issuance
during the first nine months of 2014, driven by rock bottom interest
rates, was $954 billion, compared with $1.08 trillion in the
year-ago period, according to the Financial Industry Regulatory
Authority.
Still, trading volumes have stayed about the same, according to
research from BlackRock Inc, the world's largest asset manager.
"Liquidity stinks," Toms said of corporate bonds.
Last week, sales surged of 10-year Treasury notes in a flight to
safety caused by weak signals from the U.S. economy. The yield on
the benchmark note fell below 2 percent as the stock market gyrated.
Loomis Sayles portfolio manager Matt Eagan said his $19 billion
Strategic Income Fund is close to having a record level of reserves,
largely in the form of government bonds. U.S. Treasuries account for
about 16 percent of the portfolio, a four-fold increase since the
end of 2013, he said.
He said the fund has also cut exposure to the lowest rated corporate
junk bonds because he doesn't believe he was getting paid for the
risk he was taking.
"We're giving up some yield to preserve the ability to be flexible,"
Eagan said.
But he is still hunting for home runs. For a more aggressive
investment strategy, the bond fund manager said he bought shares
from the IPO of Chinese commerce company Alibaba Group Holding Ltd
at $68 and then sold them at $91, for a quick 34 percent gain.
"It definitely added to our performance," said Eagan, who bought the
shares for the Loomis Sayles Strategic Alpha Fund, which has a
mandate to invest in a wide range of fixed income and stock
holdings.
At Fidelity's $10.5 billion Capital & Income Fund, portfolio manager
Mark Notkin made a similar play, adding Alibaba to a subportfolio of
stocks that make up about 20 percent of the fund's overall assets.
In the third quarter, the fund's stocks outperformed the junk bonds.
Alibaba's stock was a top 10 holding in the fund at the end of
September, fund disclosures show.
(Reporting By Tim McLaughlin; Additional reporting by Ross Kerber;
Editing by Richard Valdmanis and John Pickering)
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