At least four high-yield portfolio managers say they would rather run the risk of underperforming benchmark indices than get hammered again in the telecom sector. None of them plan to buy the bonds of WorldCom, and half are also steering clear ofQwest Communications. The admission by the buy-siders is significant because the credits were expected to comprise a whopping 6.8% of the Merrill Lynch High-Yield Master II index, and over 7% of the Lehman Brothers high-yield index. The bonds were added to the widely followed indices last weekend due to recent downgrades. The junk managers say they have been down the telecom road before, and do not have the stomach to add further exposure to the sector, especially because their peers are of the same mind and therefore they will not risk underperforming them.
Tom Parker, who manages $3 billion in high-yield for Barclays Global Investors, will not buy the bonds of either company. "If you work in high-yield and you were hired in the last year or two, you were hired to replace somebody who lost money on telecom. In mainstream high-yield, no one wants to make a bet on this, because if you mess up, it's like, 'How could you do this!'"
Some managers say they will stay away until pricing erosion starts to abate, and telecom companies find a way to reduce cap-ex. Michael Goldstein, who manages $3 billion in high-yield assets for Lord, Abbett & Co., says even his firm's investment-grade portfolio manager was surprised to learn that he would not buy either company's bonds, and that he had hardly given the matter a second thought. "We are benchmarked, but anyone investing based solely on a given index is misguided," he says.
The high-yield team at AIG Global Investment Corp. spent "hundreds of man hours on this analysis" and reached a similar conclusion, says Gordon Massie, who runs the insurer's $10 billion junk portfolio. AIG will not buy any WorldCom paper, as Massie worries that the company has grown through acquisitions of former high-yield companies such as Intermedia that remain under stress. He is also concerned about WorldCom's heavy debt load and cap-ex requirements.
Massie is slightly more constructive on Qwest, where AIG will take 2% positions for its third-party portfolios. He has bought the U S West operating company issues, but believes there is better value at the holding company level. The operating company's 8.875% notes of '12 (Baa3/BB+) were bid at 97.25 last Thursday, while the holding company 7.25% notes of '11 (Ba2/BB) were bid at 78. As for WorldCom, the 7.5% notes of '11 were bid at 46.5 (Ba2/BB).
Other portfolio mangers, such as Paul Ocenasek, who oversees $3 billion for Aid Association For Lutherans/Lutheran Brotherhood, say there is still time to reassess, as history has shown fallen angels tend not to outperform the market in their first three months in junk territory. AALLB will not buy WorldCom until it stops revising earnings estimates downward and has taken a less than 1% stake in Qwest, says Ocenasek.