Junk bonds begin to worry managers
So much so that two mutual fund giants are saying no to investors.
NEW YORK — The money manager’s job is supposed to be straightforward: Take people’s cash and put it to work. The more money that comes in, the bigger the manager’s paycheck.
So why would two of the country’s largest fund managers tell would-be investors in junk bonds, the common name for bonds issued by companies with the lowest credit ratings, to go away?
The short answer is that it’s for their own good. The market for junk bonds, the pros say, has become so popular that it’s dangerous.
Due largely to the unsteady economy, interest rates on U.S. government bonds have fallen to record lows. And individual investors remain leery of the stock market. Desperate for better returns, they’re sinking billions into higher- paying bonds backed by businesses with bad credit scores. Those deeply indebted companies have borrowed a record amount from investors and are increasingly using the money in ways that could strain their ability to pay it back.
This year, two mutual fund giants, T. Rowe Price and Vanguard, began turning down people hoping to invest in funds that buy junk bonds.
“It’s getting harder and harder to find places to invest,” said Michael Gitlin, director of fixed-income at T. Rowe Price. He says investors are getting paid recordlow interest rates for taking on much more risk.
Over the past 10 years, individual investors have dropped $96 billion into the junk bond market, according to Vanguard research. The bulk of it, 77 percent, was deposited in the past three years.
All that money has started to change things. For a while, falling borrowing costs and willing lenders prevented many troubled companies from sinking into bankruptcy.
But what’s good for borrowers can eventually be dangerous to investors. Fund managers and analysts now warn that the seemingly boundless appetite for bonds has eroded lending standards.
Over the past year, just 2.8 percent of low-rated companies have missed an interest payment and defaulted, according to Standard & Poor’s. That’s roughly half the long-term average. But for corporate borrowers with the worst ratings, it’s 27 percent.
Gitlin and others say recent trends remind them of the easy-lending era before the financial crisis, when Wall Street and bond traders treated caution as a sign of weakness.
“When you start seeing things like you saw in ’06 and ’07,” Gitlin said, “you should be concerned.”