NEW YORK-Martin Fridson, managing director of Merrill Lynch & Co., called this year one of “difficult times” for high-yield bonds, a period characterized by “declining liquidity in the secondary (trading) market.”
Elizabeth Mackay, investment strategist for Bear, Stearns & Co. Inc., called the status of the junk- bond market “a macro-barometer of investors’ ” willingness to speculate.
“The wider the junk-bond (yield) spreads are to Treasuries, the worse it is for technology stocks because this indicates an unwillingness to take risks.”
To provide courage for the faint of heart, Sam DeRosa-Farag, director of global portfolio strategy for Donaldson, Lufkin & Jenrette Securities Corp., offered a different perspective on speculative-grade debt.
“The main theme over the last 20 years of economic experience is that most of the less-risky assets have proven less efficient, ultimately not paying investors for as much risk as we are taking,” he said at the recent New York Society of Security Analysts “High Yield Bond Seminar.”
“As economic and financial cycles shorten and become more volatile, it is important to remember that 80 (percent) to 90 percent of all (monetary) assets on the globe are long term, seven to 30 years, so short-term volatility is not so important.”
Most issuers do not leave their long-term debt securities outstanding until they mature. Often, such debt is called and repaid prior to maturity with proceeds from an initial public offering.
The prospect that a high-yield debt security will go into default because its issuer cannot make timely interest payments is a matter of great concern to investors. In fact, it is a leading reason why issuers of such debt must pay higher interest rates than those on investment-grade bonds and notes. However, fewer than 10 percent of all high-yield bonds have defaulted in the last decade, while 70 percent were called or had an IPO transition.
“Defaults are not trivial, but they should not be newsworthy. If it shows up in the paper, it’s nonsense. By the time of a default, all you know is that the company had a problem nine to 12 months ago,” DeRosa-Farag said.
“Default is a lagging indicator, not a predictive model. Transition probabilities, like ratings changes or the sale of a company, are much more important.”
Particularly in this era of low inflation when investors are flush with cash, it is unwise to avoid speculative-grade debt, said DLJ’s co-head of high-yield research.
“Our job is not to avoid risk but to take appropriate risk. Why do we own these assets? Because junk is good for portfolio diversification,” he said.
