Crude Rout Worsens, But Bond Funds Remain Confident

Big bond investors who have bet on high-yield oil producers are sticking to losing bets, waiting for a turnaround in the price of crude, even though their performance has suffered and fund assets have shrunk as oil has plunged.

 

"Junk" rated U.S. exploration and production credits are on track to post their worst two-month performance since Barclays (BCS) records began in early 1993.

 

Energy credits became a bigger slice of the U.S. high-yield market in recent years, comprising 15 percent of it at present compared with 10 percent in December 2010, according to data from research firm CreditSights. The prospect of more defaults among high-yield energy firms has intensified in recent months.

 

These investors said they were maintaining most of their exposure to bonds of oil and gas producers even as oil prices have slumped below $28 a barrel and major banks have said the commodity could slide to $20 or lower.

 

But analysts say the clock is ticking for funds that have maintained bets on energy bonds. More investors may lose patience in the contrarian bet and pull their money, forcing managers to sell energy credits to raise cash, said Jeff Tjornehoj, head of Americas research at Lipper.

 

"Given enough time, it could work out, but that's the issue at hand: Will investors give them enough time to see this through?" he said.

 

Investors have withdrawn gobs of cash from these funds in recent months. After lagging at least 94 percent of peers last year, the funds are behind at least 76 percent of peers this month through Tuesday, according to Morningstar (MORN) data.

 

Fund managers maintain that low oil prices will lead companies to cut production, eventually driving prices back toward the $60-a-barrel level in coming years.

 

Michael Buchanan, head of global credit at Western Asset Management Co, said he pared energy investments in his Western Asset Short Duration High Income Fund in the fourth quarter of last year but still had 11.2 percent of the fund's assets in high-yield energy companies, with 5 percent in high-yield E&P bonds, down from 12.7 percent and 7 percent in September.

 

Buchanan said he sold bonds of Comstock Resources Inc , but still held credits of companies such as Sanchez Energy Corp and QEP Resources Inc.

 

"We have not capitulated in this down trade," Buchanan said. He said it was "just a matter of time" before oil producers would begin to significantly cut back production. He said he would rethink his energy exposure if he saw more compelling yield opportunities in sectors other than energy.

 

Investors pulled $348 million from Buchanan's fund last year, cutting its assets to $700 million from a peak of $1.5 billion in June 2014, Lipper data shows. The fund has lost 4 percent this year.

 

Global oversupply of crude has raised fears that producers will struggle to finance operations and service their debt, boosting defaults.

 

The percentage of high-yield debt in default issued by U.S. oil and gas producers hit 11.3 percent last month, a record since Fitch Ratings began tracking the data in 2000. But investors said they did not expect the companies they own to slip into bankruptcy since they either had access to credit, ample cash, or have hedged future production.

 

"Bottoms take a while to be put in place, but I think these are all the classic signs of a bottoming in the market, when everyone jumps on that same side of the ship that oil can only go down," said Kathleen Gaffney, who runs the Eaton Vance Bond Fund.

 

Gaffney increased her exposure to energy bonds overall in the fourth quarter from 11.2 percent to 16 percent, with the fund's bets on high-yield energy bonds increasing from 3.3 percent to 5.8 percent.

 

The BofA Merrill Lynch U.S. High Yield Energy Index posted its second-worst week ever last week, delivering a loss of 8.7 percent, exceeded only by an 11.1 percent loss in October 2008. The average yield on an energy junk bond hit a record high of 18.44 percent on Tuesday.

 

Gaffney said oil prices likely would not remain below $30 a barrel for long, and could hit $60 by the second half of this year. She reiterated a call she made in October to Reuters that a number of her fund's holdings could gain by 30 percent or more over the next two years.

 

Investors pulled $856 million from Gaffney's fund last year, slashing the fund's assets by over 40 percent to $780 million from a peak of about $2 billion last February, according to Lipper data. The fund has lost 6.5 percent this year.

 

Patrick Maldari, senior fixed income investment specialist at Aberdeen Asset Management, said the Aberdeen Global High Income Fund cut its exposure to energy overall to 7.3 percent and to high-yield E&P debt to 2.6 percent, from 10 percent and 5 percent, respectively, in October. He said, however, that the cash raised from the sales may eventually be used to invest in more high-yield energy credits.

 

Investors withdrew about 46 percent of the Aberdeen fund's assets last year, reducing its size to $989 million, according to Lipper data. The fund has lost 3 percent this year.

 

Lipper's Tjornehoj said that managers may eventually be right, and energy spreads will narrow. "But by that time they may have very little money in the portfolio to crow about."