Duration Remains Unattractive, Says Veteran High Yield Bond Investor
Oct 26, 2023
01:12:59
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Craig Manchuck, a veteran high yield bond investor, joins the podcast to discuss the end of the zero interest rate era. They explore the bond market sell-off, opportunities in the bond market, and the rise of private credit. They also talk about the impact of CLOs and passive investing on bonds, the pain from higher interest rates, and the decline of the heyday of private equity.
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Quick takeaways
The bond market sell-off in recent years can be attributed to the end of the zero interest rate era and the Federal Reserve's tightening policies, leading to a potential recession.
When investing in high yield bonds, conducting a bottoms-up analysis and focusing on credit quality are crucial for reducing downside risk and generating fair yield.
The private equity industry may face challenges in generating high returns as interest rates increase, while private credit has emerged as a significant alternative to traditional fixed income strategies, attracting attention from institutional and retail investors.
Deep dives
The Impact of Rising Interest Rates on Bonds
The podcast discusses the impact of rising interest rates on the bond market. The speaker mentions that the long duration part of the market has been experiencing significant losses. He emphasizes that the magnitude of the drawdown was not entirely unexpected, given the extended period of low interest rates experienced in recent years. The speaker also explains that the Federal Reserve's intentions to hike rates and combat inflation have contributed to the current market conditions. He mentions that his investment approach has focused on avoiding the extension of duration until the Fed signals a turn towards lowering rates. Overall, the podcast highlights the importance of being cautious and mindful of interest rate risk in bond investing.
Investing in High Yield Bonds
The podcast explores the speaker's investment approach to high yield bonds. He emphasizes that every bond is different, and it is crucial to conduct a bottoms-up, security-by-security analysis. The speaker mentions that the market has been providing opportunities in the one to two-year investment grade part of the market. He discusses the importance of reducing downside risk and finding the least risky way to generate fair yield. The speaker also comments on the risks associated with leveraged buyouts (LBOs) and the challenges of investing in private equity-owned companies. The podcast highlights the speaker's focus on credit quality and his preference for higher-quality investment grade bonds in the current market environment.
The Outlook for Private Equity and Private Credit
The podcast provides insights into the future of private equity and private credit markets. The speaker suggests that the private equity industry may face challenges in generating high returns due to the increase in interest rates. He predicts that the industry will undergo significant changes as older generations hand over to the next generation. The speaker also discusses the growth of private credit and the various investment strategies within this market. He highlights the rapid influx of money into private credit funds and the diversification of offerings, including industry-specific or size-focused strategies. The podcast emphasizes that private credit has become a significant alternative to traditional fixed income strategies, attracting attention from both institutional and retail investors.
Erosion of Covenant Protections and Rise of Term Loan B Market
The podcast discusses the historical shift in the loan market, where banks used to provide loans and enforce stringent covenant protections. However, with the rise of Collateralized Loan Obligations (CLOs) as buyers of loans, the need for extensive covenant protections has diminished. As a result, the term loan B market emerged, offering loans without advertisement requirements and with lower covenant protections. Financial sponsors found this market advantageous as they could secure cheaper funding without stringent maintenance covenants.
Impact on Bondholders and Concerns for the Financial Sector
The erosion of covenant protections, coupled with the growth of CLOs, has raised concerns for bondholders. Leveraged levels in the term loan market have increased to three and a half to five times leverage, favoring financial sponsors due to the cheap cost of capital. However, bondholders face increased risk and reduced protection. The podcast highlights the need for vigilant analysis and the importance of alternative protection measures such as low leverage or a defensible business. Additionally, the podcast raises concerns about the future of banks in the leverage finance world, as private credit gains prominence and banks' profitability and durability come into question.
On todays episode, Craig Manchuck Vice President & Portfolio Manager at Osterweis joins the show for a discussion on the end of the zero interest rate era.
We deep dive into the bond market sell-off over the past 3 years, where to find opportunities in the bond market & the rise of private credit. To hear all this & more, you'll have to tune in!
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Timestamps:
(00:00) Introduction
(00:43) The Low Interest Rate Era Is Over
(06:55) The Fed's Tightening Will Lead To A Recession
(17:47) Investing In A Zero Rate Regime vs Today
(23:34) The Indexation Of Fixed Income
(27:22) How CLOs & Passive Have Impacted Bonds
(41:33) Where Is The Pain From Higher Interest Rates Being Felt?
(48:10) The Heyday Of Private Equity Is Over
(01:00:19) Liquidity In Private Credit
(01:09:35) Understanding The Credit Spread Curve
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Disclaimer: Nothing discussed on Forward Guidance should be considered as investment advice. Please always do your own research & speak to a financial advisor before thinking about, thinking about putting your money into these crazy markets.
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