QT could see BBB-rated bonds tumble into HY
February 12, 2019

Large swathes of BBB-rated corporate bonds could be poised to lose their investment grade status as quantitative tightening amplifies volatility and ultimately triggers credit downgrades through worsening fundamentals, warns Craig Veysey, lead fund manager of the Man GLG Strategic Bond fund.

Veysey, who with portfolio manager Francois Kotze joined Man GLG from Sanlam FOUR at the end of 2018, says the percentage of triple B-rated bonds has "exploded" since 2008 as companies have geared up their balance sheets in order to buy back stock and finance other equity-friendly activity.

He warns that many of these bonds, particularly those issued by cyclical companies, could leave investors nursing capital losses if they are downgraded to high-yield as pre-quantitative easing levels of volatility return to the market.

"The suppression of volatility we've seen in recent years due to quantitative easing is reversing direction with quantitative tapering likely to amplify volatility," he says. "At the same time the economic cycle is not as constructive as it was, with leading indicators weakening in many parts of the world. We are very, very cautious of those cyclical BBB- issuers that lack the flexibility to reduce the size of their balance sheet or increase their cashflow – we think a large number of these could quickly find themselves in the high-yield index."

Veysey is instead focussing on more appealing defensive opportunities including special situations, particularly where companies are seeking to deleverage, improve their credit quality and avoid shareholder-friendly activity.

"We have recently been buying bonds in Tesco, which has overseen a huge turnaround in the business," he says. "Tesco is now only one rating agency upgrade away from moving from sub-investment grade to investment grade and we think that's likely to happen in the next few months. It is tendering for its bonds on a regular basis and it does so at a price significantly higher than the market price. Plus, investors will become forced buyers of the debt when Tesco is moved up to investment grade."

Another special situations trade Veysey highlights is Macy's, the US department store chain. "We bought it last summer when the Amazon story was impacting major US retailers quite significantly," he says.

"But what was missed is that Macy's has stores in prime locations in all the major US shopping malls, and management that has actively engaged with shoppers and improved its offering. It is also looking to deleverage and is embarking on tender offers at attractive levels for debt investors. We will look to build up our position as we expect issues to be tendered for again over the next 12-18 months."

 





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Large swathes of BBB-rated corporate bonds could be poised to lose their investment grade status as quantitative tightening amplifies volatility and ultimately triggers credit downgrades through worsening fundamentals, warns Craig Veysey, lead fund manager of the Man GLG Strategic Bond fund.

Veysey, who with portfolio manager Francois Kotze joined Man GLG from Sanlam FOUR at the end of 2018, says the percentage of triple B-rated bonds has "exploded" since 2008 as companies have geared up their balance sheets in order to buy back stock and finance other equity-friendly activity.

He warns that many of these bonds, particularly those issued by cyclical companies, could leave investors nursing capital losses if they are downgraded to high-yield as pre-quantitative easing levels of volatility return to the market.

"The suppression of volatility we've seen in recent years due to quantitative easing is reversing direction with quantitative tapering likely to amplify volatility," he says. "At the same time the economic cycle is not as constructive as it was, with leading indicators weakening in many parts of the world. We are very, very cautious of those cyclical BBB- issuers that lack the flexibility to reduce the size of their balance sheet or increase their cashflow – we think a large number of these could quickly find themselves in the high-yield index."

Veysey is instead focussing on more appealing defensive opportunities including special situations, particularly where companies are seeking to deleverage, improve their credit quality and avoid shareholder-friendly activity.

"We have recently been buying bonds in Tesco, which has overseen a huge turnaround in the business," he says. "Tesco is now only one rating agency upgrade away from moving from sub-investment grade to investment grade and we think that's likely to happen in the next few months. It is tendering for its bonds on a regular basis and it does so at a price significantly higher than the market price. Plus, investors will become forced buyers of the debt when Tesco is moved up to investment grade."

Another special situations trade Veysey highlights is Macy's, the US department store chain. "We bought it last summer when the Amazon story was impacting major US retailers quite significantly," he says.

"But what was missed is that Macy's has stores in prime locations in all the major US shopping malls, and management that has actively engaged with shoppers and improved its offering. It is also looking to deleverage and is embarking on tender offers at attractive levels for debt investors. We will look to build up our position as we expect issues to be tendered for again over the next 12-18 months."

 



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