BlackRock Rushes to Short End as Goldman Alarmed: Credit Markets
The world’s biggest buyers of corporate debt are seeking refuge in shorter-maturity bonds as concern deepens that a three-decade rally will end in losses as interest rates rise.
BlackRock Inc. is planning two actively-managed exchange- traded funds focused on short-term debt, with one seeking to have principal repaid within a year, the world’s biggest money manager said in regulatory filings. Loomis Sayles & Co. has favored five- and 10-year corporate notes since April as it’s shifted away from 30-year bonds at its Core Plus Fixed Income team, which oversees about $9.5 billion, said Peter Palfrey, a money manager at the Boston-based firm.
Debt from the most-creditworthy borrowers has become more vulnerable with the extra yield investors demand to hold the notes rather than Treasuries declining an unprecedented 4.56 percentage points since the end of 2008, reducing the cushion that helps preserve gains when benchmark rates rise. Goldman Sachs Group Inc. President Gary D. Cohn said this week he’s concerned some investors don’t understand that bonds will lose value as benchmark yields inevitably climb from record lows.
“We do see a significant increase in appetite for shorter- dated, shorter-duration exposures,” Edward Marrinan, a macro credit strategist at RBS Securities in Stamford, Connecticut, said in a telephone interview. “That’s a trend that is gaining traction.”
U.S. investment-grade corporate bonds that mature within one to three years have returned 0.27 percent this year, compared with a 0.71 percent decline for debt of all maturities, Bank of America Merrill Lynch index data show. Last year, the notes underperformed the broader market by 5.9 percentage points.
Average duration on the high-grade debt, which has gained an annualized 9.1 percent since the start of 1980, reached a record 6.95 years on Oct. 31 before declining to 6.78 years as of yesterday, Bank of America Merrill Lynch index data show. That compares with 5.4 years in October 2008 during the worst financial crisis since the Great Depression and a 6.07 year average over the past decade.
Because prices of longer-maturity bonds are more sensitive to changes in current market yields than shorter-dated debt, an equal rise in borrowing costs reduces more value from longer- dated notes that pay a larger number of coupons.
“There is really only one way that interest rates can go,” Cohn said Feb. 11 in a Bloomberg Television interview. “I’m concerned that the general public doesn’t quite understand the pricing of bonds and interest rates and the inverse correlation between the two.”
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. fell, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 1.4 basis points to a mid-price of 85.9 basis points as of 11:39 a.m. in New York, according to prices compiled by Bloomberg.
The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.32 basis point to 15.56 basis points as of 11:39 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Comcast Corp. are the most actively traded dollar- denominated corporate securities by dealers today, accounting for 6.2 percent of the volume of dealer trades of $1 million or more, at 11:40 a.m. in New York, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. The largest U.S. cable company said yesterday it will buy out General Electric Co.’s ownership of NBC Universal for $16.7 billion.
BlackRock’s iShares Liquidity Income Fund will aim to oversee a portfolio of dollar-denominated investment-grade debt with a weighted average life that’s less than one year, according to a Feb. 4 prospectus. Michael Evan and Richard Mejzak are set to manage the fund’s debt purchases.
The firm also has proposed an iShares Short Maturity Bond Fund, another actively managed ETF that would seek to maintain an average effective duration of a year or less, according to a Sept. 5 filing. Fixed-income ETFs, which trade like stocks and price in real time, are used by retirees to banks to speculate on debt that’s traditionally traded over the counter.
“We’ve been moving out of a lot of 30-year paper that we had been in over the summer, when we thought we were being compensated for the price risk,” said Palfrey, who helps manage the $1.65 billion Loomis Sayles Core Plus Bond Fund. The shift has been more pronounced in holdings of junk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
“We want to be positioned such that over the next 12 months we have less interest rate sensitivity than the rest of the market,” Palfrey said in a telephone interview from Boston.
Concern that investment-grade bonds are poised for losses is mounting as 10-year Treasury yields rise to about the highest level in 10 months. Yields on Treasuries increased to 1.98 percent as of yesterday, up from 1.76 percent at year-end and compared with a record-low of 1.39 percent on July 24, Bloomberg data show.
“For people that were staying in the short-end of the duration spectrum, we welcome the move to higher rates,” said Thomas Murphy, who oversees about $26 billion of investment- grade credit at Columbia Management Investment Advisers LLC in Minneapolis. “We’re excited about it.”
The Federal Reserve has held benchmark interest rates in a range of zero to 0.25 percent since December 2008 and plans $85 billion in monthly bond purchases to ignite an economy still recovering from the credit crisis.
The government intends to suppress borrowing costs for the world’s largest economy as long as unemployment remains above 6.5 percent and inflation remains no more than 2.5 percent. The jobless rate rose to 7.9 percent last month from 7.8 percent in November and December.
Last year, longer-maturity debt outperformed shorter bonds. Dollar-denominated investment-grade bonds maturing in 10 years or more returned 13.2 percent last year, compared with 6.6 percent on notes due in one to five years, Bank of America Merrill Lynch index data show.
This year, the debt maturing in one to five years has gained 0.23 percent versus a loss of 2.3 percent on bonds maturing in 10 years or longer.
“People want to move out of rates, long-duration type assets,” James Keenan, the head of BlackRock’s $28 billion leveraged finance unit, said in a Feb. 8 Bloomberg Television interview.
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