The number of credits toppling from investment grade to high-yield ratings status has increased, making life difficult for managers who can invest only in investment-grade bonds. With another six companies taking the drop over the past month, managers are wrestling with where to put their money and what to do about bonds they did not expect to have to worry about.
"Overall, this whole situation is a big headache for investors," said Gary Wolfer, senior portfolio manager of around $680 million in investment grade credits at Univest Wealth Management. "It diverts your attention from simply managing money and now you have to worry about whether or not you should pull out of what was a safe, profitable investment grade credit. And I don't see it getting any easier or ending anytime soon."
Managers looking for somewhere to put cash will likely turn to asset-backed and mortgage-backed securities, as well as higher quality investment grade credits. Tim Warrick, portfolio manager of roughly $31 billion at Principal Global Investors, said many portfolio managers will move up the credit spectrum. "You can move upward and invest in 'A' rated credits or higher and accept the tighter spreads in order to gain safety, or you can look to other sectors, since the fallen angels in question are primarily corporates." Wolfer agreed, noting that the spread on asset-backed and mortgage-backed securities is more relative to the risk. The key there, he said, is to look for the best coupon with the shortest call.
But looking to greener pastures is only one issue. Warrick said minding what is already in the stable is a bigger concern. "With the new issue supply being not as robust, especially in investment grade, the biggest concern is just to try and avoid the losers," said Warrick. "Just trying to maintain stable credits you already own is a bigger issue than where to put new cash."
Wolfer said it is essential to consider the sector in relation to fallen angels. No matter how good a credit may look, if it's in a volatile sector, such as airlines or autos, it's like owning a nice house in a bad neighborhood, he said. "You really need to look at the sector, especially in this environment," he said. "I would be more comfortable owning Valero(BBB-) than I would Verizon (A+) because the telecom industry is volatile and I'm more comfortable with oil and gas." Wolfer adds that he still feels very comfortable with many of the lower quality investment grade credits in his portfolio and sees them as retaining high investment value. Wolfer holds names such as Daimler Benz, rated BBB by Standard & Poor's, and Enron Oil & Gas, BBB+.
Warrick believes that the popularity of credit default swaps and collateralized debt obligations will continue to act as backstops for the market. "They are really causing risk to be spread around and the fundamental problems with some of these borderline companies are becoming more glaring," he concluded.
Jeff Layman, investment grade director at BKD Wealth Advisors, agreed. "This entire situation is going to make investors more aware of the risks that are involved, even with these high-grade credits. There are always risks, even at this level of bonds," he said.
