High-yield bond deals increasingly are being cut in favor of bigger loan pieces and investors do not see the market picture getting rosier anytime soon. Some $1 billion has been sliced and shifted from bonds to loans over the past three weeks and at least another $350 million has been dropped altogether. High-yield players do not have much taste for what has been on tap, and most do not see things improving. "I think that the high-yield market still has plenty of room to weaken further," said Chris Kostiz, portfolio manager at Advance Capital Management. "I've heard from colleagues that there is the possibility that things could be even worse within the next 12-18 months."
Right now, things are pretty bad. "I've been here since the start of the firm in 1993 and I've never seen the high-yield portfolio so low," said Kostiz, who manages a $400 million portfolio. "We have a high end limit of 33% high yield and right now it's about 17-18%, less than half." In light of the current climate, Kostiz has been focusing on investment grade credits.
Tom Parker, manager of a $3.5 billion high yield portfolio at Barclays Global Investors, said hedge funds are partly responsible for the state of the high-yield market. "Deals do get done but with hedge funds...they are really out of their element," he said. "You almost have to entice them into the market because it is not their area. Nothing can get done at the original price talk, and to top it off this hasn't been a good high yield year anyway. We're under 2% for the year and we've had five up months and four down months." Parker also noted that the excess demand for leveraged loans as a major factor in the current situation. "It's gotten to where you see CLO deals every week; there are definitely more yield oriented people nowadays," he said.
Recent new issue deals that have come to market such from companies such Neiman Marcus and Cendant have had their bond portions cut and a planned bond deal for School Specialty was scratched. Both Neiman and Cendant traded down when they broke for trading in the loan market last week.
Kostiz agrees with Parker that hedge funds are playing a role. "If hedge funds weren't involved there is a chance that this might not be happening," he said. "They are propping up the new issue market by buying into deals that don't make a lot of sense right now while others are left to chase the secondary market."
Parker said he believes that there is a minor chance that a recovery could occur in November as high yield is typically seasonal and November is usually a solid month for that market. "For the most part I expect this to continue," he said. "We will only see an end when we get a consensus view on whether the economy is up or down, for starters." He feels that the sectors that will suffer the most from this trend are paper, packaging and autos; sectors that will have higher default rates.
