Distressed-focused funds have found difficulty investing money as the U.S. Federal Reserve holds interest rates near zero and global corporate defaults remain low. Such defaults fell to
66 last year from a peak of 266 in 2009, according to data from Moody’s Investors Service. Oaktree this year cut the $3 billion goal on its control-investing fund by about 40 percent as it struggled to find opportunities.
The firm, led by Chairman Howard Marks, doesn’t expect the dry spell to last for long. “Credit standards have dropped and non-investment grade debt issuances reached record levels,” John Frank, Oaktree’s managing principal, said July 31 on a conference call with investors and analysts. “Aggressive extensions of credit of the sort we’re seeing today have always been a precursor to a substantial distressed-debt opportunity.”
A number of headlines have reported that covenant-lite lending has surpassed the 2007 peak again this year and highlighted that this is far from a healthy medium-term development. The momentum of lending to high risk credits is being fuelled by yield to maturity investors who cannot accept the return on Treasuries while rates are so low. Pension funds and other such groups have an expected rate of return they have to achieve. Since this cannot be gained from yields they are forced into relying on capital appreciation. So far this year, the trade has worked out with Treasury prices rallying. Monitoring the consistency of the trend will be important as the anticipated change to Fed monetary policy draws closer.
BBB Corporate bond spreads over Treasuries are as tight as at any time between 2004 and 2007 and a sustained move above 175 basis points will be required to confirm a return to supply dominance.
US 10-year Treasury yields have been compressing steadily since hitting 3% in early January. While less than 50% of last year’s spike higher has been retraced, a sustained move above the 2.55% area would be needed to break this year’s progression of lower rally highs and to suggest a return to supply dominance beyond the short term.
Oaktree Capital has been ranging below $52 since May following an abrupt decline but will need to sustain a move above that level to suggest a return to demand dominance.