Author Archives: CFAMNEB

…and the winner is….

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Investment Grade Credit had a really solid week. It might not win best actor in the market, but it turned in a really nice performance, generating total returns of around 70 basis points for the week (our best guess right now, before all the data is in…), and excess returns compared to treasuries of about 8 basis points. The long end was once again the star – for the month of February, long Corporates were up close to 2%, with excess returns of over 1%. Credit overall was up around 1% in February, with excess returns of around 60 basis points.

What’s interesting is that there was a lot going on this week – both on the economic front and the geopolitical front – that could have derailed the market for credit. But after a run of weak data which has been mostly discounted due to weather, we ended up with strong housing numbers and durable goods orders, which helped support spreads. And the saber rattling over the Ukraine seemed enough to keep a lid on rates. Finally, Janet Yellen’s weather-delayed testimony on Thursday seemed to give both rates and risk a bit of a boost. We know she’s not saying anything much different than her predecessor – asset purchases will be reduced at a measured pace, they are continuing with their program, but they will react to any significant change in the outlook. There’s just something soothing about how she says it. Janet Yellen definitely gets our vote for best actress.

The new issue market responded with about $30 billion in supply this week – the biggest week since early January. Cisco was by far the largest issuer, bringing $8 billion across 7 tranches; bonds were well priced, and we think they were among the better performers this week. 3 year bonds did especially well, tighter by 11 basis points, while the 10 year was tighter by 3. Goldman Sachs, Williams Partners, Juniper Networks, Fifth Third Bank, and CMS Energy were all in the market this week, and all performed well, but our vote for best supporting actor goes to Cisco based on the sheer audacity of their performance.

Next week we are expecting to see another $20 billion in supply; that number may go higher if this week’s drama has a happy ending.  And for best screenplay, the winner is…

Get Lucky

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The news in credit this week was dominated by the merger announcement between Comcast and Time Warner Cable – just in time for Valentine’s Day. Time Warner Cable bonds took a big hit last June, with spreads widening by about 150 basis points in response to romantic overtures from John Malone at Charter communications. Prices of TWC’s long bonds dropped by about 15-20 points, and have been languishing ever since on fears that Malone would prevail, and the company would lose its investment grade ratings. Comcast was an on-again, off-again suitor in this ménage a trois, and we wondered if they would ever take the relationship seriously. For credit investors who held onto, or took positions in TWC bonds during this drawn-out courtship, they finally got lucky. Immediately following the announcement of the all-stock deal, TWC bond spreads gapped about 125 basis points tighter, and the long bonds soared about 15 points. Not a bad one-day return for investment grade credit. One of the factors driving the deal seemed to be the desire on the part of management to pursue an all stock transaction, as it would help bondholders as well as stockholders. As creditors, we just aren’t used to seeing that kind of love.

Credit investors who held on during the January-end Emerging Market anxiety attack also got lucky, as spreads have tightened over the past week almost to the levels we saw before the mini-risk flare. Month-to-date excess returns are positive, and the long end is once again leading the way. We think part of the spread movement in secondary paper has been driven by a relatively light calendar, as the weather (and New York City weather in particular) continues to play an outsized role in our market. Taking out the Sovereign issuers, we were left with just $14 billion in supply, dominated by the bank sector with $4.25 of 3 year fixed and floaters out of JPMorgan, $2.75 billion 3 year floaters and 5 year fixed from Barclays, $1.75 billion 3 year fixed and floaters from Bank of America, and $2 billion from Cap One across 3 shorter duration tranches. If you did not want to buy short bank paper, you were definitely out of luck in new issue this week. Next week is looking better though – at this point there may be some pent-up supply, so we’re counting on at least $20 billion. If you’re willing to wait, you could get lucky.

You Gotta Know When to Hold ‘Em

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Disciplined Growth Investors

The inspiration for this article came from two blockbuster investment pieces published in the early 1980’s. The first was titled “The Greatest Financial Story ever told”, written by Greg Smith, the lead investment strategist for Prudential Securities. The second was titled “Revenge of the Nerds”, written by Stan Salvigson, a strategist at Merrill Lynch. Both titles were clever and a clear signal that these pieces were going to be different. And they were. Both correctly laid out the investment framework for the foreseeable future, a future in which financial instruments (primarily bonds, derivatives and stocks in financial service companies) would be the winning investments. Remarkably this strategy lasted until 2008, a span of over 25 years.

We hope to convince you that the U.S. financial markets are entering a new era, in which the key to investment success will be to invest in the stocks of winning companies at fair prices or less and hold them for long periods of time.

Innovative enterprises will be the champions of the new era. Their springboard for success will be their successful exploitation of the massive technological innovations which have been brewing for over thirty years. Enterprises must learn to think and behave differently in order to prosper in the new paradigm. There will be at least three major variables which will need to be addressed:

  • People – The winning enterprises of the future understand that their most important assets are their people. Long-term success will be contingent upon an enterprise’s ability to attract and retain the right knowledge workers. At a minimum, this means establishing a culture defined by a high level of trust and transparency.
  • Tools – Once the enterprise has the right people on board, they will need to provide the tools that help maximize individual potential. We define tools broadly to include both the devices and domain knowledge that will spur productivity gains. This means each enterprise must have a proactive stance toward new technology and the ongoing education of its personnel.
  • Systems – Finally, the winning enterprises of the future will understand that maximizing individual potential is not the same as maximizing the potential of the enterprise. To be successful, the organization must design and implement systems that act as a multiplier to individual contributions.  The most obvious of which is developing an innovation engine that leverages the collective insights of the organization

Read the full article

Wild Horses

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Emerging markets have taken center stage in the credit world over the past week, just in time to usher in the year of the Horse in China.  Here’s what we’ve learned about Horses: they are active and energetic and full of ambition. They are also hot-headed and impatient, and this sure felt like a week where the hot-headed prevailed. Fears about the potential impact of higher rates in Turkey, Brazil, South Africa, and other emerging economies had an obviously negative impact on equities, but also helped to push Treasury bonds higher and credit spreads wider. Total returns in corporate bonds this month are positive on an absolute basis, but excess returns are slightly negative. It has not been a very big move in credit, to be sure. While equities are down about 3%, broadly speaking, credit spreads are just 5 basis points wider. Some sectors, like banks and mining, have seen a little more volatility, but it’s been a modest move so far.

The spread volatility did keep a lid on new issue this week – the market saw just $13 billion in supply, heavily skewed towards the banks. Given the weak tone to the market, deals actually performed reasonably well, and look like they are generally trading a basis points or two tighter – though not without some noise. We expect that the calendar will pick up a little bit next week, as more companies get through earnings season. But if we see further volatility coming from emerging markets, all bets are off. Many high quality issuers were active in tapping the markets in 2013, so there is not a lot of pent-up supply, and you could see a sharp drop in new issue if volatility continues.

To say it has been a wild start to the New Year might be an overstatement. Let’s just hope they aren’t dragging us away before its over…

One Hundred Years of Solitude

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We have all heard complaints about how lonely it is being a portfolio manager. Good decisions are celebrated by the team, but bad decisions seem to be made alone. Not that it was a bad week in credit – everything was just fine. Spreads were perhaps a touch weaker, but excess returns are still positive for the month, interest rates are cooperating, and market tone feels pretty good.

This is probably what paved the way for about $45 billion in investment grade supply, and investment grade sovereign issuers added another $8 billion. One of the notable issuers last week was EDF (Electricité de France), which globally brought over $12 billion in supply, of which about $6 billion was in US Dollars. Among the bonds issued was a new 100 year bond – the 7% of 2114. Now that is credit risk worth thinking about.

In the late 1990s, there was a spate of 100 year issuance, and some of the credits have fared better than others. Fox America (formerly NewsCorp) has improved somewhat since issuance in 1996. JCPenney, on the other hand, has sunk from being a solid, single-A rated company to a CCC company. From a credit standpoint, this underscores the perils of underwriting a bond for such extended periods. How, exactly, do you evaluate 100 years of credit risk?

The answer may be – you don’t. Beyond a certain period of time, we think insight into business fundamentals grows a bit foggy. Even so, these bonds can still make a lot of sense from a portfolio standpoint, particularly if you are hedging long duration liabilities. The duration of a 100 year bond is not much longer than that of a 30 year bond, but you generally get a lot more convexity, so you should outperform as interest rate volatility increases.

All that convexity should really make you feel better when credit quality tanks. There’s no way around it, buying a 100 year bond introduces loneliness that could be handed down from generation to generation.