Bargains on Wall Street are hard to find after the fierce 2020 rally that swept through stock and bond markets. Some investors are sifting through complex securities that were among the hardest hit during the panic of this past spring.
Bonds backed by commercial real estate and corporate loans traded for less than 50 cents on the dollar after the pandemic hit and margin calls triggered forced selling. Their recovery has lagged behind the broad market rebound that followed, in part because the selloff wrought havoc with the finances of many firms that buy these securities.
But now, with vaccine distributions rolling out and many other asset classes having rallied to prices few expected to see, fund managers see attractive returns in the year to come.
The risk is plain to see. The bonds are rated below investment grade and can be linked to properties and companies with high vulnerability to the pandemic, like hotels, mall retailers and airlines.
Still, relatively low prices mean the bonds offer “protections you can’t find anywhere else with this kind of yield,” said
a portfolio manager at CIFC Asset Management who buys collateralized loan obligations, Wall Street reformulations of lower-rated debt. “There’s still a ton of catching up to do versus the broader market.”
CLO managers buy up bundles of corporate loans then slice them up and repackage them into bonds with credit ratings ranging from the safest triple-A to much riskier single-B. Investors like Mr. Huang are buying up the lower-rated bonds, which pay higher interest rates but are first to take losses if corporate defaults rise.
In late December, such 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 is far more than the 2.9-4.1 percentage-point spread paid out by conventional corporate bonds with the same credit ratings, according to data from BofA Securities and ICE Data Services.
Bonds backed by real-estate loans are also attracting bargain hunters.
In November, hedge-fund manager Brigade Capital Management snapped up bonds backed by a $240 million mortgage loan to the owner of two luxury hotels in Portland, Ore. The bonds were trading around 65 cents on the dollar, reflecting concerns about the tolls the coronavirus and political turmoil have taken on tourism in the city.
The prices imply that “no one will ever travel to Portland and stay in these high-end hotels again,” said
co-head of the structured finance team at Brigade that made the trade. Such doomsday scenarios are unlikely to pan out, and in the near term mortgage lenders are granting property owners forbearance to tide them over, he said.
Brigade bought similar debt backed by a Nashville, Tenn., hotel this past spring for around 60 cents on the dollar, Mr. Ross said. The bonds traded in December at around 88 cents on the dollar, according to data from ICE Data Services.
Brigade has been raising new funds to capitalize on the investment opportunity in low-rated asset-backed debt, a person familiar with the matter said. Other fund managers are doing the same. Hildene Capital Management launched a fund in May to buy lower-rated CLO securities. The investment vehicle returned around 26% in 2020, a person close to the firm said.
head of U.S. securitized products at Janus Henderson Investors, has increased holdings of commercial mortgage-backed securities in the firm’s multisector income fund to 9% from around 3%.
In more beaten-down parts of the market, he has focused buying on higher-rated bonds. At the same time, he has bought sub-investment grade bonds in the multifamily housing, industrial and biomedical office subsectors.
“For funds like us, money managers, this is kind of the ideal opportunity to look at what we think of as cheap bonds,” he said.
Asset-backed bonds trade at higher yields than comparably rated corporate bonds during market turmoil because they have a less stable buyer base. Money moves quickly out of the sector when investors turn fearful and is slower to return when sentiment improves.
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Toward the end of the year, spreads on CLO bonds with double-B ratings had tightened about 3.5 percentage points since May, retracing 64% of the amount that they widened earlier in the year, while spreads on speculative-grade corporate bonds had retraced 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 part in 2020’s slow recovery, investors and analysts said.
When markets plunged earlier in 2020, many firms felt pressure from banks to sell at steep losses to meet or prevent margin calls. Months later, some still don’t have the buying power they once did.
A prominent example is residential mortgage real-estate investment trusts, which typically buy residential mortgage debt but can also purchase commercial mortgage securities.
Having met heavy pressure from banks, residential mortgage REITs in the FTSE NAREIT Mortgage REIT Index held $324 billion of assets on Sept. 30, down 37% from the end of 2019, according to a Wall Street Journal analysis.
“A lot of people had good levered trades on, were testing them for a normal recession, and then the world fell apart,” said
head of securitized products research at BofA Securities. The result was “the decimation of capital,” which has dragged on the market.
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