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And So It Begins - Managed High Yield Bond Fund Liquidates After 17 Years

Since inception in June 1998, UBS' Managed High Yield Plus Fund survived through the dot-com (and Telco) collapse and the post-Lehman credit carnage but, based on the press release today, has been felled by the current credit cycle's crash. After 3 years of trading at an increasingly large discount to NAV, and plunging to its worst levels since the peak of the financial crisis, the board of the Fund has approved a proposal to liquidate the Fund. While timing is unclear, this is the worst case for an increasingly fragile cash bond market as BWICs galore are set to hit with "liquidty thin to zero."

 

Having survived 17 years...

 

It's Over... (as The Fund Statement reads):

Managed High Yield Plus Fund Inc. (the "Fund") (NYSE:HYF) announced today that the Board of Directors (the “Board”) of the Fund has approved a proposal to liquidate the Fund in 2016, subject to shareholder approval.

 

After careful deliberation and a thorough review of the available alternatives, and based upon the recommendation of UBS Global Asset Management (Americas) Inc. (“UBS AM”), the Fund’s manager, the Board has determined that liquidation and dissolution of the Fund is in the best interests of the Fund. A proposed plan of liquidation will be submitted for the approval of the Fund’s shareholders at a special shareholders meeting of the Fund, which will be scheduled to be held in April 2016. If the shareholders approve the proposed plan, the liquidation and dissolution of the Fund will take place as soon as reasonably practicable, but in no event later than December 31, 2016 (absent unforeseen circumstances).

 

Further information regarding the liquidation proposal, including the plan of liquidation, will be included in the proxy materials that will be mailed to the Fund’s shareholders in advance of the shareholders meeting.

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This is a nightmare for the corporate credit market, where, as we noted previously "liquidity is thin to zero."...

...discussing illiquid corporate credit markets is easier if you find yourself among polite company. You see, the lack of liquidity in the secondary market for corporate bonds is a somewhat benign discussion because although it unquestionably stems from a noxious combination of regulatory incompetence and irresponsible monetary policy, myopic corporate management teams and the BTFD crowd, not to mention ETF issuers, have also played an outsized role, so there’s no need to lay the blame entirely on the masters of the universe who occupy the Eccles Building and on the "liquidity providing" HFT crowd that’s found regulatory capture to be just as easy as frontrunning.

 

But while explanations for the absence of liquidity vary from market to market, the response is becoming increasingly homogenous. Put simply: market participants are simply moving away from cash markets and into derivatives. Where market depth has disappeared, it’s become increasingly difficult to transact in size without having an outsized effect on prices. This means that for big players - fund managers, for instance - selling into ever thinner secondary markets is a dangerous proposition. And not just for the manager, but for market prices in general.

In Treasury markets, traders have turned to futures to mitigate illiquidty... 

...while corporate bond fund managers utilize ETFs and other portfolio products to avoid trading the underlying assets...

With the stage thus set, Bloomberg has more on the move to smaller trades and cash market substitutes:

Sometimes less is more. At least according to investment managers trying to navigate Europe’s credit markets.

 

TwentyFour Asset Management capped a bond fund to new investors at 750 million pounds ($1.2 billion) and JPMorgan Asset Management, which is marketing a 128 million-pound fund, said smaller investments are more flexible in a sell-off. Other managers are also limiting the size of their trades and using derivatives to avoid getting trapped in positions.

 

It’s become more difficult to buy and sell securities as Greece’s financial crisis curbs risk taking and dealers scale back trading activity to meet regulations introduced since the financial crisis. The Bank for International Settlements warned of a "liquidity illusion" in June because bond holdings are becoming concentrated in the hands of fund managers as banks pull back.

 

"Liquidity is generally poor in corporate bond markets and in the U.K. market it’s thin to zero," said Mike Parsons, head of U.K. fund sales at JPMorgan Asset Management in London. "You don’t want to be in a gigantic fund where there’s potential for a lot of investors rushing for the exit at the same time. Smaller funds are more nimble."

 

"Without enough strong liquidity, it’s hard to execute bond trades in sufficient size or price to move portfolio risk around quickly or cheaply," he said. "The bigger the position, the harder it is to find enough liquidity to sell it or buy it."

 

Liquidity in credit markets has dropped about 90 percent since 2006, according to Royal Bank of Scotland Group Plc. That’s because dealers are using less of their own money to trade as new regulation makes it less profitable.

 

Euro-denominated corporate bonds got an average of 5.3 dealer quotes per trade last week, up from 4.5 recorded in January and compared with a peak of 8.8 in 2009, according to Morgan Stanley data. That’s based on dealer prices compiled by Markit Group Ltd. for bonds in its iBoxx indexes.

 

Liquidity is especially bad in the U.K. corporate bond market, which is being abandoned by companies looking to take advantage of lower borrowing costs in euros and investors seeking securities that are easier to buy and sell.

 

NN Investment Partners said it seeks to manage difficult trading conditions by diversifying positions and capping trade size. The Netherlands-based asset manager avoids owning large concentrations of a single bond and uses derivatives such as credit-default swaps or futures that are easier to buy and sell, said Hans van Zwol, a portfolio manager.

 

"We really want to stay away from positions we can’t get out of," he said.

The conundrum here is that the more reluctant market participants are to venture into increasingly illiquid cash markets, the more illiquid those markets become.

And here are the fund's largest holdings...

 

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Of course, this should not be a total surprise, in light of the near-record up/downgrade ratio...

Credit-rating firms are downgrading more U.S. companies than at any other time since the financial crisis, and measures of debt relative to cash flow are rising.

 

 

Standard & Poor’s Ratings Services downgraded U.S. companies 297 times in the first nine months of the year, the most downgrades since 2009, compared with just 172 upgrades.

Deteriorating fundamentals...

U.S. companies have increased borrowing to levels exceeding those just before the financial crisis, as firms pursue big acquisitions and seek to boost stock prices by buying back shares. According to one metric, the ratio of debt to earnings before interest, taxes, depreciation and amortization for companies that carry investment-grade ratings, meaning triple-B-minus or above, was 2.29 times in the second quarter. That’s higher than the 1.91 times in June 2007, just before the crisis, according to figures from Morgan Stanley.

“We’re seeing more widespread weakness across more industry sectors in the U.S.,” Ms. Vazza said. “It’s become broader than just the commodity story.”

 

“The metrics that you measure health and credit by have peaked a while ago,” said Sivan Mahadevan, head of credit strategy at Morgan Stanley. “They are beginning to deteriorate.”

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And as we noted earlier, the credit cycle has well and truly rolled over...

 

And no lesser market veteran than Art Cashin is concerned, What are the signals you are looking for to stay on top in such a market?

 I continue to monitor the high yield market and see where that goes. The high yield market has been of some concern of the last several weeks. If that begins to show appreciable weakness than I would think the caution flags stay up.

 

Charts: Bloomberg