Bargains on Wall Street are hard to come by after the fierce 2020 rally that swept through the stock and bond markets. Some investors are sifting through complex stocks that were among the hardest hit in the panic last spring.
Bonds backed by commercial real estate and business loans traded at less than 50 cents on the dollar after the outbreak of the pandemic and margin calls sparked forced sales. Their recovery has lagged behind the general market rebound that followed, in part because the sale wreaked havoc on the finances of many companies that buy these securities.
But now, with the rollout of vaccine distributions and many other asset classes having rebounded at unexpectedly low prices, fund managers are seeing attractive returns in the year ahead.
The risk is obvious. The bonds are rated below the investment rating and can be tied to properties and businesses that are highly vulnerable to the pandemic, such as hotels, mall retailers and airlines.
Yet relatively low prices mean that bonds offer “protection that you won’t find anywhere else with this kind of return,” said Jay Huang, head of structured credit investments at CIFC Asset Management who buys secured loan bonds. , Wall Street reformulations – rated debt. “There is still a lot of catching up to do with the larger market.”
CLO managers buy batches of corporate loans, then slice and repackage them into bonds with credit ratings ranging from the safest triple-A to the much riskier single-B. Investors like Mr. Huang buy lower-rated bonds, which pay higher interest rates, but are the first to suffer losses if corporate defaults rise.
At the end of December, these CLO securities offered an additional yield, or spread, of 8.8 percentage points to 13 percentage points above the benchmark London interbank offered rate, or Libor. That’s far more than the 2.9 to 4.1 percentage point spread paid by conventional corporate bonds with the same credit ratings, according to data from BofA Securities and ICE Data Services.
Bonds backed by home loans also attract bargain hunters.
In November, hedge fund manager Brigade Capital Management bought bonds backed by a mortgage loan of $ 240 million from the owner of two luxury hotels in Portland, Oregon. The bonds were trading around 65 cents on the dollar, reflecting concerns about coronavirus tolls and political unrest has taken tourism to the city.
The prices imply that “no one will ever go to Portland again and stay at these upscale hotels,” said Dylan Ross, co-head of Brigade’s structured finance team who did the trade. Such doomsday scenarios are unlikely to materialize, and in the near term, mortgage lenders are giving homeowners forbearance to avoid them, he said.
Brigade bought a similar debt backed by a hotel in Nashville, Tennessee, last spring, for about 60 cents on the dollar, Ross said. The bonds were trading in December at around 88 cents on the dollar, according to data from ICE Data Services.
Brigade raised new funds to capitalize on the low-rated asset-backed debt investment opportunity, a person familiar with the matter said. Other fund managers do the same. Hildene Capital Management launched a fund in May to buy lower rated CLO securities. The investment vehicle brought in around 26% in 2020, a person close to the company said.
John Kerschner, head of US securitized products at Janus Henderson Investors, increased the holdings of commercial mortgage-backed securities in the company’s multi-sector income fund from about 3% to 9%.
In the more difficult parts of the market, he focused on buying higher-rated bonds. At the same time, he bought lower quality bonds in the multi-family housing, industrial office and biomedical sub-sectors.
“For funds like us fund managers, this is sort of the perfect opportunity to look at what we think of as cheap bonds,” he said.
Asset-backed bonds trade at higher yields than corporate bonds of comparable rating during market turmoil because they have a less stable buyer base. Money comes out of the sector quickly when investors are afraid and comes back more slowly when sentiment improves.
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By the end of the year, spreads on CLO bonds with a double B rating had tightened by around 3.5 percentage points since May, retracing 64% of the amount they had widened earlier in the year. the year, while spreads on speculative-grade corporate bonds had returned to 92%, according to data from BofA Securities and ICE Data Services.
The use of leverage by many buyers of asset-backed bonds also played a role in 2020’s slow recovery, investors and analysts said.
When markets plunged earlier in 2020, many companies felt pressure from banks to sell at large losses to meet or prevent margin calls. Months later, some still don’t have the purchasing power they once had.
A good example is Residential Mortgage Real Estate Investment Trusts, which typically buy residential mortgages but can also purchase commercial mortgage securities.
After coming under heavy pressure from banks, residential mortgage REITs in the FTSE NAREIT Mortgage REIT index held $ 324 billion in assets as of September 30, down 37% from the end of 2019, according to an analysis of the Wall Street Journal.
“A lot of people had good leveraged deals, tested them for a normal recession, and then the world fell apart,” said Chris Flanagan, head of securitized products research at BofA Securities. The result was “the decimation of capital”, which dragged on the market.
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