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"the dash for trash"

David_Snowball
in Fund Discussions
James Mackintosh today warns of investors' "dash for trash."
...the riskiest part of the bond market has performed the best. The CCC-rated borrowers closest to default have returned 10% this year. The worst-performing are safe investment grade borrowers ... Just as junk-bond investors like the trashiest investments, big stocks with the weakest balance sheets ... are beating those with stronger balance sheets ...
Why? No recession which kept the marginal firms afloat and forced continuing high interest rates which plagued investment-grade borrowers. Even without a recession, refi is going to knife many of those companies which will ripple out. Mr. Mackintosh identifies three tiers of likely victims, starting with "the obvious disasters: super-speculative also-rans that financed themselves in the final stages of the post pandemic boom, mostly using SPACs, plus some debt-financed zombies that should have gone bust but were saved by zero interest rates."

A companion article, by Jon Sindreu, walks through the size and timing of the debt threat. Two special notes. First, ratings firms have not kept up with re-rating issuers in light of interest rate changes (some "marginal" firms might, in light of higher rates, below in the "dumpster fire" box). Second, the poop will hit the propeller in 2025 with the peak of the refinancing wave. ("Higher-for-Longer Rates are Debt Threat")

Debt investing makes my head spin but these struck me as useful yellow- or red-flags for prudent long-term investors.

On a marginally related note, Mr. Sherman's CrossingBridge Pre-Merger SPAC ETF (SPC) is a top 25% performer YTD in Morningstar's calculation, which considers it a financial sector equity fund with a return of 3.55%. Last year it was a top 1% performer when Morningstar called it as small-growth fund, with a 2% gain against its average competitor's 14% loss.

Comments

  • hank
    edited July 2023
    ”...the riskiest part of the bond market has performed the best.”

    Thanks David. Great post. That’s the sense I’ve been getting, but don’t have much experience in this area. Junk can hold up well for long periods, even as equities languish, and than tank badly. Can give a false sense of security sometimes.
  • sma3
    I bought a small amount based on Sherman's track record and the rational behind liquidating SPACs. So far no windfalls, but steady Eddy

    M* "quant" (ie AI) analysis is embarrassing. You would think they would limit using it to traditional vehicles, not alternative investments
  • David_Snowball
    The most embarrassing element of the machine-written text is its shamelessness. "Compared to other small-growth equity funds, this one has exceptional risk management" or whatever. Computer Dude, it's not a small-growth fund and your blissfully confident cluelessness serves no one well.
  • JunksterJunkster
    https://www.reuters.com/markets/default-wave-imminent-will-peak-2024-deutsche-bank-2023-05-31/

    From the end of May a very ominous forecast for the default rate on both junk bonds and loans in late 2024. If the default rates of 9% and 11.3% comes anywhere close to reality it would be one bad bear market for junk and bank loans. One positive is I have a treasure trove of such predictions over the past decade of the eventual demise of these markets based on default rates, debt maturity walls etc. that haven’t come close to reality.
  • hank
    edited July 2023
    Thanks @Junkster. Value your perspective. My concern wouldn’t be so much with dedicated HY funds where you understand what you’re getting into. Maybe a great trade. Don’t know. But I suspect many unwary investors might get drawn into funds with more benign sounding names ( like “multi-asset”, “diversified income”, etc.) which have loaded up on the junkiest junk to boost returns near-term - and draw in assets, of course.
  • BaluBalu
    Why are bank loans projected to be effected by maturity / refinance in 2024 if they are already making their interest payments through at least 9-12 months of 5% fed fund rates? Presumably they are floating rate loans and the rates have already been reset to the higher rates. I would think the general economy or the sector in which the debtor operates has to tank for the bank loan borrower to default. They have already shown they could manage the current interest rates, unless they borrowed more than needed for their business and are currently making the interest payments from that excess cash. This excess borrowing can not be a systemic problem in the bank loan area as much as it is in the HY area which tapped the public markets.
  • yogibearbullyogibearbull
    FR/BL have long maturities but short duration due to their frequent rate resets. BUT near maturity, they also face re-fi risks in bad economic environment.
  • davidsherman
    rossingBridge Pre-Merger SPAC (SPC) is a ultra short term fixed income alternative is which the SPAC is purchased and redeemed. I think the option to get an excess return from an announced transaction to sell into the news is highly suspect unless MEME investing comes back. SPC is not an equity comparison. (C) I did mention REITs are serial dilution to grow AUM but under rare circumstances I find them interesting and one should look at the Funds to see the if we find any of interest.
  • MikeMMikeM
    edited July 2023
    I added SPC to my conservative withdrawal bucket pretty much at inception. It now makes up about 20% of that account, about 2x as much as RPHYX at 10%. It's on pace to make 6-7% this year. Not sure you can find a more consistent trend up than SPC since Sept. 2022. I bought in because I trust the manager.
  • BaluBalu
    RPHYX is closed to new investors.
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