You look great in Blue, but this pink dress
Guest post by Peter Tchir.
There was some chatter about the performance of fixed income ETF’s yesterday. They performed poorly at least relative to stocks and some had a late day sell-off fueling some speculation that credit wasn’t doing well.
That speculation was just wrong, but highlighted so,e problems with existing fixed income ETF’s.
They were trading at a premium and that premium tends to disappear when bonds become easy to source. While HY bonds remained well bid, the investment grade bond market is being flooded with new issues – primarily to enable large one time dividends. Might be worth probing into these companies a little deeper, but that is for another day.
So premium versus bond availability explains some of the noise, but to a large degree that is secondary.
The biggest problem facing investment grade and even to a large extent high yield, is that all the ETf’s (and most funds) are yield products not spread products.
While spreads tightened yesterday (especially in the fast money, overly shorted CDS market) bond prices in some cases were down because the move in treasuries outpaced the spread tightening.
If you have time this weekend, read any article about the credit markets and it will drone on and on about spreads but then only give yield investments. Why tell someone they look great in blue, only to offer the pink dresses?
While HY is traditionally not very sensitive to rates (and is often negatively correlated) there is currently a large portion of the market that is. Many of the big BB bonds out there trade more like investment grade bonds and the rate risk is real.
I would rather own spread product than yield product here and the only reason I’m not obsessing about rates is that the Fed is going to do everything possible to keep them tame until unemployment is below 7%. Potentially a very long time.
I also think equity is more interesting than credit here. Too many bonds in HY, the ones that aren’t BB and exposed to rate risk, have awful convexity which limits their upside as they can be called anytime. Expect HY19 a spread product to outperform HYG – I really like that trade here.
Alternatively move into “second order products” or shift money to those who are good at managing them. Illiquid credit is worth a look. The non ETF, non hedge fund go-go bonds still offer a yield pick up versus their over owned brethren and let’s be honest, those “liquid” bonds are rarely that liquid when you NEED them to be. Old structured mortgage debt is interesting but harder to find than a right call on CNBC. Middle market lending, project finance and some other areas abandoned by big banks and not picked up by small banks are gaining a lot of alternative attention – tricky area but can offer real value. CLO paper can be good, and at this pace some will be tempted to resurrect the synthetic CDO market. There are some great opportunities there – many for technical reasons that can generate returns In a hurry.
Basically go ugly early because you will anyways. This chase for yield (and spread) will continue so look for what people will buy next (less liquid) and make sure you own what expresses your view (if you like spread, don’t just buy yield).