In normal times, junk bond traders will often have ratings downgrades priced in well before the ratings agencies get around to making it official. Today though, traders are making bigger moves than normal in response to the agencies’ downgrades of junk bonds. David Caleb Mutua reports for Bloomberg:
Usually, when a credit-rating firm downgrades a company, bond prices move much less, because the securities had weakened weeks or months earlier when investors first suspected trouble. In each of 2017 and 2018, bonds from a high-yield company that got cut would have lagged the index by just 5 percentage points, according to Barclays.
Investors may be paying more attention to high-yield ratings moves now because as junk bonds continue to rally to new highs, many money managers are getting more worried about the downside of owning notes that could default, according to Bill Zox, chief investment officer for fixed income at Diamond Hill Capital Management.
“In the late part of the cycle, it is especially important to avoid the land mines,” Zox said. “When a company trips up, the market shoots first and asks questions later.” Diamond Hill oversees around $23 billion in assets including junk-rated debt.
Read More in this Week’s Credit Brief: Junk Downgrades Rattle Investors
While money managers are still spotting trouble early and lightening up on their holdings of troubled companies, they are using downgrades as signals that they need to sell even more securities amid risks of a broader deterioration in credit markets, Zox said.
That may be why some of the biggest price declines after downgrades come when bonds are cut to what is essentially the lowest tradeable tier of high-yield debt, those graded in the CCC area, according to a Jan. 10 Barclays note.
Read more here.