Stuffed on junk

October 8, 2009

Risky assets like high-yield bonds have been riding high this year, but it looks like it’s time to get sober. The market surged nearly 40 percent in the first nine months of the year, and the feeding frenzy has allowed even companies with risky credit profiles like Ford Motor and casino operator MGM Mirage to sell bonds. That could be about to change.

After bingeing on risky assets for months, mutual funds are starting to look, well, stuffed. Fund managers have largely reversed the panic trade seen last fall when Armageddon was on everyone’s lips and safe-haven Treasury bills on everyone’s order books.

In September, high-yield bond funds reined in their investments in junk bonds, purchasing only $1.09 billion compared with $2.18 billion in the prior month, according to data tracking service Lipper FMI.

It’s true that mutual funds make up only about 20 percent of the purchasing power in the market, but their behavior has been a reliable indicator of which way the wind is blowing in the bond market.

Martin Fridson, a junk bond market guru and head of Fridson Investment Advisors, reckons the slowdown is significant, especially considering how much money has been transferred out of short-term investments like Treasury bills — the ultimate haven for investors during the crisis — this year.

Lipper shows that between October 2008 and January 2009, money-market mutual fund inflows spiked by $487 billion. A combination of unprecedented intervention by the government in financial markets and restored confidence in big Wall Street banks, however, encouraged investors to reverse course, with $451 billion leaving the safe haven of money market funds between February and September.

Fridson argues that money that would ordinarily be earmarked for risky assets already has most likely been redeployed, meaning that the powerful pop in markets like high yield could fade into a more hum-drum business of more moderate returns.

This is a positive development, since it should bring to some much needed sobriety to a market that is in danger of becoming much too accommodative. Last week, TransDigm Group Inc, a maker of commercial and military aircraft parts, convinced junk bond investors to lend it $425 million to pay its shareholders a special dividend.

Surely, it’s too early in the recovery to start using borrowed funds just to make shareholders happy. Hopefully, sated mutual funds will stop such free and easy fund-raising from taking root.

One comment

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Where are the rating organizations like S&P and Moody’s on this? Are they going to again get away with rating bonds AAA when they don’t even know how bad off the issuers are.

It is hard to believe this is happening right in the middle of the Simmons Mattress disaster. Some how the market bought hundreds of million of dollars worth of Simmons bonds more than the company was worth or could pay. Like other investors, I want to see some real assurance that the bond issuers are legitimate. The markets should demand this.

Posted by R. Lamar Smith,CPA | Report as abusive