The incredible shrinking bond market
SWF pull billions from bonds; flight to quality in high yield.
The overwhelming mentality in the capital markets in the first weeks of 2016 remains that of siege. “This has been an unprecedented start to the year,” says one DCM banker. “All good news is discounted and all bad news is amplified.”
In fixed income, that bad news is coalescing around one thing: the oil price. “The impact and influence of oil prices are clearly very important, but moves in that market were often drowned out in the first days of the year by equity volatility and Asian news,” says Lee Cumbes head of SSA origination, EMEA at Barclays. “This has since gained more appropriate attention. Twenty dollars is a number we never would have talked about as a credible oil price forecast last year.”
As prices remain suppressed, concern is mounting over the extent to which this will trigger withdrawals of funds from fixed income. The most immediate indication of the effect of such behaviour has been among hydrocarbon-dependent sovereign wealth funds.
Sovereign wealth funds (which account for 5% to 10% of assets under management worldwide) have sold off $75 billion in equities and $110 billion in bonds as oil prices have plunged, according to JPMorgan. Research firm Preqin calculates that total assets under management at sovereign funds derived from hydrocarbons stood at $3.44 trillion in March 2015, up from $2 trillion in December 2008. That growth has now ground to a halt, or reversed, as the oil price has tumbled. This will have a big impact on the volume of funds that these entities now put to work in the asset management industry.
Dubai-based market intelligence firm Insight Discovery estimated, last September, that Saudi Arabia’s SAMA alone had withdrawn between $50 billion and $70 billion from global asset managers in the previous six months. Assets under management at SAMA Foreign Holdings fell from $757.2 billion in December 2014 to $668.6 billion by January this year.
Large sovereign wealth fund redemptions, combined with retail nervousness, mean that many bond funds could shrink a lot this year. One of the largest bond funds in Europe, M&G’s Optimal Income fund, lost a quarter of its assets in 2015, falling from a peak of £25 billion to £17.33 billion by November – a drop of almost £8 billion.
If the oil price does not recover, not only will many investors have fewer assets under management, they will also have a changed universe to invest those assets in.
Standard & Poor’s predicts that 6% of all US energy corporates will default in 2016: last year, 26% of all corporate defaults were energy companies and there are now roughly $100 billion of high-yield energy bonds trading at distressed prices. According to Barclays, if oil prices remain at current levels, an additional $155 billion, or 12% of the entire US high-yield universe, will be added to the market as the result of fallen angels. This would wipe 35 basis points of return from the Barclays US corporate index.
“The consensus is still not for the oil price to stay where it is,” says one banker. “No one has budgeted for oil at this level. But Opec is playing a long game.”
This will only exacerbate the flight to quality in the corporate bond market that was so starkly illustrated by the $46 billion seven-tranche deal in early January to finance the takeover of SAB Miller by Anheuser-Busch (AB InBev).
There are many reasons that this deal attracted such an overwhelming response: it was the first big M&A trade out of the gate, the issuer is well regarded, with a strong track record in large acquisitions and a recession-proof product. It also delivers on deleveraging and guards its credit rating closely – all of which is attractive to buyers.
Despite this, however, the $110 billion of orders defied expectations and showed how desperate buyers are to get their hands on high-quality paper. AB InBev paid a new issue premium of just 10bp to 15bp to raise $46 billion, where US telecoms operator Verizon had famously paid a premium of 100bp to raise just $3 billion more in 2013.
“The high-yield market, especially energy issues, has been backing up for some time,” says Som-lok Leung, executive director of the International Association of Credit Portfolio managers. “On the other hand, AB InBev demonstrates there’s still a considerable amount of money available for certain sectors and certain companies. We may be looking at winners and losers rather than an overall correction.”
For now, bond investors’ focus on the effect of the oil price on both their clients and what they invest in is all-consuming. Research firm Morningstar reckons that 75% of all US fixed-income funds have some energy exposure.
“The lower oil price implies lower inflation, which has helped high-quality fixed income markets, but it should also be a dividend to consumers too. However, this second influence is often not as easy to decipher or quick to have effect on the data,” says Cumbes.
His colleague Marco Baldini, head of European corporate and SSA syndicate at Barclays, points to credit as the most likely cypher for the wider oil price impact, particularly on fund redemptions. “There is significant concern over exposure to the energy sector that started in the US high-yield market but has now spread to all markets,” he says. “People are worried about redemptions from funds. You see the price break more in credit than in SSA because these firms have a smaller audience. The market is repricing for a new cycle.”