Robert Marquardt is founder, chairman, and co-head of investment management at Signet Group, responsible for overall portfolio management and for development of the group’s investment strategy. He is a member of Signet’s investment committee and leads the group’s top-down process of identifying investment opportunities while focusing on the most pertinent investment risks; he is also intimately involved in hedge fund due diligence. Marquardt has two decades of experience with alternative investments. Before founding Signet in 1993, he was an independent investment manager based in Luxembourg (1990–93). This followed a successful career as a credit analyst and lending officer with Chase Manhattan Bank (1979–90) in London and Bahrain, and in Luxembourg, where he was the director in charge of private banking.
We had a tumultuous last half of 2011, with the European sovereign debt crisis dominating markets. How did this impact corporate borrowing in the high-yield corporate bond market?
The first week of December 2011, leading up to the heads of government meeting on the Eurozone on December 9, may have been an inflection point as far as the European sovereign debt crisis is concerned. The markets by then were already pricing in the very substantial probability of Europe slipping into recession in 2012, along with the deflationary impact that this could be expected to have.
The head of the European Central Bank (ECB), Mario Draghi, who succeeded Jean-Claude Trichet in October 2011, is very experienced and he is a realist. He will know that while the ECB puts a huge premium on price stability, the possibility of a deflationary environment taking hold cannot be ruled out if Europe slides into a severe recession. This perception is likely to shape ECB policy, and whatever the ECB chooses to do will clearly have a huge impact on the European sovereign debt question. Already we have seen the ECB moving to grant three-year loans to banks at 1%. This has been taken up on a huge scale by European banks and has gone a long way to relieve liquidity pressures in the interbank markets.
The way both hedge funds and traditional long-only managers are playing this current period of deep uncertainty has been to move as much as possible into cash. The hedge funds have gone largely to cash, and even large private clients have sold out of assets and moved to cash. It follows from this that there is a huge war chest out there on the sidelines waiting to participate as the markets start to move in a positive direction. This adds greatly to the volatility that we are seeing in markets, with 200–300 point daily swings occurring as a matter of course as risk-on, risk-off trading rules.
At the same time, we saw fewer companies launching new bonds at the back end of 2011, which is understandable given the heightened levels of uncertainty in the markets.
Along with the downward pressure on markets, there have been several surprise upward spikes of activity. Market sentiment was so bearish through the last quarter of 2011 that reactive bounces were bound to occur. All it takes is a single “event,” such as a positive statement from a senior European politician, to move markets upward, while the least negative news sends them downward once again. One of the reasons for this extreme volatility, of course, is precisely the fact that liquidity has withdrawn from the markets as people moved to cash. In low-volume, low-liquidity trading conditions, minor selling and buying moves markets in an amplified fashion.
To what extent does the present situation parallel the onset of the crash in 2008?
Though there are similarities between the present situation and the onset of the crisis in 2008, there are some major differences as well. Where you had the subprime crisis fueling the downturn in 2008, we now have the sovereign debt crisis. In 2008 there was almost no liquidity in the markets. Everyone wanted to sell and no one wanted to be a buyer. Today there is a growing lack of liquidity in the market, but it is being caused by the fact that everyone has moved to cash and is sitting on the sidelines, waiting for the fog to clear. The big advantage we have now, as opposed to back in 2008, is that stocks and high-yield bonds are now priced correctly. Bond managers feel this as much as equity managers.
High-yield bonds that were at par, or 100%, are now trading at 67–72% of their par value. If you add to this the fact that interest rates are up at 9% to 12% on corporate debt, that gives the opportunity for a tremendous upside for bond investors.
The statistics show that bonds tend to get pulled back to par value over time. Obviously the closer a bond gets to maturity, the less reason anyone has to discount it, so corporate bond investors can look forward to both a capital gain and a coupon return that is way above anything that can be earned in the risk-free or low-risk space.
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