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A French Challenge To Gundlach's 'Disaster' Bond Theory
FYI: A record month for inflows into corporate bonds is "setting up a disaster for when rates rise & `investors' learn that, yes, these bonds have rate risk" was yesterday's latest tweeted warning from Jeffrey Gundlach. So what would the billionaire bond manager make of the first BBB-rated borrower actually getting paid to sell new bonds? Regards, Ted https://www.bloomberg.com/news/articles/2017-11-17/a-french-challenge-to-gundlach-s-disaster-bond-theory
I don't think this is a 'challenge' at all and in fact I think it supports this theory. I understand Gundlach as warning that investors are too interested in bonds that have interest rate risk and they most likely don't understand what will happen when rates go up.
He warned of dangers in the high-yield market. “Covenant-lite” (bonds with weak protections for investors) as a percentage of total loan issuance has averaged over 70% for the last three years, versus never being above 33% from 2003 to 2012.
With regard to the investment-grade market, he said the average duration is 7 but investors “don’t think prices can go down. Watch out, they have interest-rate risk.”
Is there any way to evaluate whether a high yield manager is investing in "covenant-lite" bonds? I presume the ratings of bonds don't tell you as they focus on the health of the company and the risk they'll default rather than the protections investors have if they do default.
It's the quality of the business much more than covenants that provide protection to bond holders. You're already giving up lots of protection by investing in junk - the entire company may be shaky, or these may simply be very junior bonds, the first to default if the company later develops problems.
(Remember too, that Meridith Whitney predicted a massive run of defaults in munis, which she later clarified to include "technical defaults", i.e. minor breaches of covenants; for the most part real money wasn't affected.)
LS writes that "As it turned out, covenant-lite loans did relatively well versus covenant heavy loans over the course of the global financial crisis [see graphic data in paper]. In fact, the [ratings] agencies admitted as much, but could not let go of the concern and warned that maybe next time it will be worse. Maybe, maybe not."
Gundlach continues to push his sector of the market (mortgage backed securities) without explaining the specific risks associated with the asset class that relate directly to changing interest rates:
“Buy things that people foolishly don’t understand, like mortgaged-backed bonds,” Gundlach advised.
“Get out of things, like investment-grade bonds, that people don’t understand ..."
Comments
Here's another piece on Gundlach's current perspective and hopefully it hasn't been posted before: https://advisorperspectives.com/articles/2017/11/17/gundlachs-top-etf-recommendation?
He warned of dangers in the high-yield market. “Covenant-lite” (bonds with weak protections for investors) as a percentage of total loan issuance has averaged over 70% for the last three years, versus never being above 33% from 2003 to 2012.
With regard to the investment-grade market, he said the average duration is 7 but investors “don’t think prices can go down. Watch out, they have interest-rate risk.”
Is there any way to evaluate whether a high yield manager is investing in "covenant-lite" bonds? I presume the ratings of bonds don't tell you as they focus on the health of the company and the risk they'll default rather than the protections investors have if they do default.
Here's a background paper by Loomis Sayles (admittedly written at the tail end of that 33% covenant-lite junk bond period, as opposed to the current 70% environment). Its headline states clearly that what matters is credit quality. The text goes on to explain what covenants can and cannot do in terms of protection.
https://www.loomissayles.com/internet/InternetData.nsf/0/0BF67A378755F21085257B5000566A43/$FILE/CovenantLitePaper.pdf
(Remember too, that Meridith Whitney predicted a massive run of defaults in munis, which she later clarified to include "technical defaults", i.e. minor breaches of covenants; for the most part real money wasn't affected.)
LS writes that "As it turned out, covenant-lite loans did relatively well versus covenant heavy loans over the course of the global financial crisis [see graphic data in paper]. In fact, the [ratings] agencies admitted as much, but could not let go of the concern and warned that maybe next time it will be worse. Maybe, maybe not."
Gundlach continues to push his sector of the market (mortgage backed securities) without explaining the specific risks associated with the asset class that relate directly to changing interest rates: Say what?