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Bond Buyers Go to Cash in Bet on Fading Corporate Debt Rally

The high cash levels underscore how difficult it is for fund managers to navigate a decades-long bond rally that may be due for a correction.

By Claire Boston

(Bloomberg) --The holding that corporate bond funds are most excited about now is cash.

With investment-grade company debt having notched gains of 3 percent this year, money managers like Vanguard Group Inc. and Loomis Sayles & Co. say there are fewer bargains around, and they are reluctant to keep buying. Corporate bond funds held their highest level of cash at the end of March in two years, according to data from Morningstar Inc. Trading volumes in the securities dropped in April as did new offerings.

The high cash levels underscore how difficult it is for fund managers to navigate a decades-long bond rally that may be due for a correction. Investors are still buying at least some of the debt. Money keeps flowing into corporate credit funds, which added $3.75 billion in the week ending May 17 across junk and investment-grade, according to data provider Lipper. But more and more, investors are sitting on incoming money until prices get a little more reasonable.

“We have lots of dry powder because volatility is low,” said Greg Nassour, co-head of investment-grade portfolio management at Vanguard. “If you don’t have enough, it becomes harder to pull the trigger when opportunities present themselves," he said. Vanguard manages $4 trillion of assets.


The list of situations that could spur a market correction is long.  Oil prices, Chinese economic growth, tightening from the U.S. Federal Reserve, European elections and trends in U.S. consumer consumption are all possibilities, according to Matt Fey, director of research for Franklin Templeton’s corporate and high-yield group, who said his team is monitoring these factors and others.

Morgan Stanley analysts warned investors in a note this month that returns may stay low in 2017. The surge in bond sales that accompanied easy monetary policy has sparked higher leverage, longer duration and weaker credit ratings across issuers, they wrote, and these factors may mean credit is closer to reaching its peak than traders believe. They’re recommending investors hold higher-rated assets to improve liquidity.

Painful Correction

Whenever corporate bonds do weaken, it can be fast and painful for investors. Risk premiums, or the extra yield over Treasuries that investors demand for holding corporate bonds, jumped almost half a percentage point for investment-grade bonds during the worst of the oil rout at the beginning of last year.

A steep drop like that is what some investors are waiting for.

“We’re trying to be patient,” said Brian Kennedy, a money manager at Loomis Sayles, which oversees $250 billion. He said he’s been holding more reserves in the past three to four months and selling off riskier holdings like convertible bonds. “The low level of yields overall has made it a little bit more difficult to find individual securities that you find really attractive.”

Almost half of high-yield credit investors and 14 percent of investment-grade credit buyers surveyed by Bank of America Corp. are sitting on above-average amounts of cash this month. For junk-bond investors, that’s the highest cash allocation since March 2016. Open-ended corporate bond funds held an average of 2.32 percent of their holdings in cash at the end of the first quarter, the highest since the first quarter of 2015, according to Morningstar data.

Lower Volume

Investors’ reluctance to buy now may also explain why corporate bond trading volume fell by about 20 percent from the first three months to April, averaging $28.5 billion a day that month, according to the Securities Industry and Financial Markets Association. Fixed-income trading revenue in general for the big banks could fall about 5 percent in the second quarter, JPMorgan Chase & Co. analysts wrote in a note on Tuesday.

Many money managers say they don’t like their options, according to the Bank of America survey. Seventy-eight percent of high-yield money managers said they think bonds are overvalued at current prices, up from just 25 percent in the same month last year.

Even if cash is hot, investors keep buying new bond issues. Becton, Dickinson & Co. received $35 billion of orders for its $9.7 billion debt sale on Monday, according to a person familiar with the matter. Risk premiums on investment-grade corporate bonds, at around 1.12 percent on average, are close to their narrowest levels since 2014.

“There’s a lot of capital that’s been reaching for yield and duration for a long time that’s going to start to see negative numbers,” said Henry Peabody, a money manager at Eaton Vance Corp., referring to an eventual drop in bond prices. Eaton Vance manages $381 billion. “With that, there’s going to be opportunity for those who can take advantage of it.”

--With assistance from Donal Griffin.To contact the reporter on this story: Claire Boston in New York at [email protected] To contact the editors responsible for this story: Nikolaj Gammeltoft at [email protected] Dan Wilchins

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