High yield debt defaults are at peak - Threadneedle
GLOBAL - Asset owners looking tap high yield bond opportunities created by the credit crunch may have missed the best returns, according to asset management Threadneedle, as a predicted fall in default rates from the beginning of next year is likely to lead to a tightening of spreads.
Barrie Whitman, head of high yield bonds at Threadneedle Investments, said bond defaults appear to have peaked over the last three months and are likely hit their maximum by the end of this year, which in turn is likely to leave high-yield debt looking overvalued once the fragility of debt levels begins to ease.
"Looking at the default environment, what we have seen is a rapid rise in defaults. The run rate is over 10%, after an extremely low default rate of 7-8%. And they have accelerated quicker than we were anticipating at the beginning of the year as we have hit a peak of defaults more rapidly than we were expecting," said Whitman.
"It has slackened off, we would anticipate defaults will peak at the end of this year at 11-12%. We are more concerned about US than European high yield, but now we feel that defaults will peak in '09 rather than 2010.
"At a near 50% return [on investment since the credit crunch began], you might be forgiven for thinking this market has come too far too quickly, but the rally is very much the reaction to the forced sell-off. Spreads look pretty reasonable for this stage of the cycle. They should be rallying hard ahead of the defaults, and the market will always anticipate them, so it is not unusual.
"Our issue is if this market rallies on hard, this could be overvalued in terms of what it delivers against the defaults. I would say at current levels [high yield bonds are] likely to outperform [government and investment grade debt] but if the market creates a value bubble over the next 3-6 months that will make it much more difficult," he added.
Whitman quoted figures suggesting were the recent distressed debt restructuring to be included in these figures, the actual global default rate for bonds rated B- or lower would look more like 13%.
The current default rate in Europe is approximately 6-7% but that is expected to peak at 10% by the end of this year before concerns about corporate debt improve, albeit default rates have only begun to peak within the last two months across European debt, said Whitman.