Bond bubble or no>, companies offered a record number of new bonds in the first quarter and still couldn't meet investor demand. But what's been good for companies hasn't necessarily been good for investors, and critics say this is just one more sign of an impending pop.
In the first three months of 2011, issuance of high-yield bonds increased 36% globally and 29% domestically compared to the first quarter of 2010, making it the biggest quarter on record for junk bonds, according to Matthew Toole, an analyst for Thomson Reuters. Investment-grade bond issuance was up too 14% globally and 19% in the U.S., hitting the highest level in almost three years.
And with ultra-low rates elsewhere, investors have been clamoring for these new issues. Investors are now requesting two or three times the amount of bonds coming to market, says Andrew Catalan, managing director of investment grade strategies for Standish. Demand is so robust that what would normally be a surplus and a buying opportunity has turned into a shortage. Investors are picking up the new bonds so quickly that this time, yields are shrinking.
And with the Federal Reserve keeping interest rates low across the board, companies have also been able to borrow cheaply. On average, high-yield bonds are paying 4.7 percentage points more than Treasurys, and investment-grade bonds are paying 1.6 percentage points more both of which are down about 23% compared to the average since 2003, according to Standard & Poor's Global Fixed Income Research.
Low yields may not be the only concern for investors, experts say. The frenzy for corporate bonds has also made it easier for companies to issue deals with fewer investor protections. For example, payment-in-kind bonds, where companies have the option to pay investors with more debt instead of cash, are on the rise a sign that investors are willing to accept more risk, says James Dailey, portfolio manager of the Team Asset Strategy fund. It's also a signal the corporate bond market is due for a tumble, he says. PIKs, as they're known, are still just a small fraction of the market, at 1.8% of the high yield-bonds issued so far this year, but last year they made up only 0.1%, according to Dealogic, an investment banking data firm.
Many retail investors also may not realize that at least some of the demand is artificial. Just as during the housing bubble home prices were inflated by people looking to make a quick profit by flipping a house, bond prices are now being pushed up by traders who purchase new bonds only to sell them immediately at a profit, says Lon Erickson, corporate bond fund manager for Thornburg Investment Management. While it's difficult to track exactly how many of those buyers are so-called "flippers," the trend makes it "frustrating for people like us who want to buy and hold," says Erickson.
For buy-and-hold investors, there is at least some good news: Corporate bonds are not as risky as they once were, with projected default rates expected to decline to 1.6% in March 2012 from 2.5% a year ago, according to Standard & Poor's. But experts still say the salad days are gone: With both investment-grade and high-yield bonds trading at or very close to their historical averages, there's not much appeal. "You have a lot less cushion for mistakes," says Erickson.