Thursday12 March 2020 ★ FINANCIAL TIMES 19
MARKETS & INVESTING
J O E R E N N I S O N
Nearly $110bn of bonds sold by energy
companies in the US have fallen into
distressed territory after a plunge in
theoilpriceleftinvestorsdoubtingthat
themoneywouldbepaidback.
Almost 12 per cent of the $936bn of
bonds issued by US oil and gas compa-
nieswere trading on Monday with a
yield more than 10 percentage points
above Treasuries — a commonly used
definition of distress — according to
indices run by Ice Data Services. Yields
rise as prices fall.
Among junk-rated borrowers, issuers
with ratings below triple B, which
account for $175bn of the total, the pro-
portion of debt in distressed territory
has risen to almost two-thirds.
“There is definitely a significant
amount of default risk,” said Michael
Anderson, a strategist at Citi, adding
that a lot of bondswere in the “danger
zone” where a default or restructuring
looks likely.
The falls in the bonds come in the
wake of the failure of Opec and Russia
late last week to agree a deal oncutting
production, which in effect crapped as
three-year pact between Riyadh and
Moscow to prop up crude prices.
Instead, Saudi Arabia has indicated it
will boost supplies by record amounts as
it seeks togain share nd drive rivals outa
of business. WTI crude was trading at
less than $34 a barrelyesterday, a little
over half the highs of January.
Theprice war as dealt a severe blowh
to shale-oil producers in the US, many of
which had been struggling to break even
with crude at much higher levels.
A $477m bond maturing in 2022issued by Denver-headquarteredSM
Energy, or example, lost more than halff
its value on Monday, tumbling from 90
cents on the dollar on Friday to 42 cents.
Callon Petroleum nda Oasis Petro-
leum, both of Houston, also suffered
falls of more than 40 cents on the dollar
in the price of their debt.
Energy debt has led the sell-off across
high-yield bonds, sending the average
yield for the sector to its highest level
since early 2016 on Monday.
The tough conditions were also evi-
dent in higher rated debt.Occidental
Petroleum’s $1.5bn bond maturing in
2029 plummeted on Monday, sinking
from 97 cents on the dollar on Friday to
as low as 72 cents. It rebounded to 77
cents on Tuesday after the company
announced acut to its dividend.
Analysts have warned that the shift in
investor sentiment will weigh on com-
panies’ ability to refinance debt. Almost
$27bn of US oil and gas bonds come due
this year, according to S&P Global.
Mr Anderson said: “It seems like the
financial markets are suffering more
and more volatility and extreme moves
than we have had historically. A lot just
seems to happen all at once.”Fixed income
Saudi-Russia price war puts $110bn
of US energy bonds on the brink
S O N G J U N G - A , H U D S O N LO C K E T T
A N D E DWA R D W H I T EWhen South Korean housewife Song
Mi-kyung invested in an exchange
traded fund linked to crude oil prices
five years ago, she thought she was on
toasurething.But Ms Song is among the retail traders
that have been hit by this week’s crash in
oil prices after investing in the country’s
booming market for quirky, derivative-
linked products.
ETFs like the one Ms Song bought are
so-called structured products — a sector
where investmenthas grown by 500 per
cent over the past 10 years.
The market is valued at about $87bn
(Won104tn). The instruments are often
marketed at pensioners seeking a
chunkier yield on their savings and
include roughly $1.5bn in derivatives
tied to the price of oil.
In less volatile market conditions,
some structured notes can perform like
bonds, paying out a single-digit coupon
until maturity. But investors risk losing
their entire principal if the price of the
underlying asset — such as oil — falls
below a threshold.Ms Song’s nightmare scenario materi-
alised this week when Saudi Ara-
bialaunched an oil price war, prompt-
ing the price of crude oil to crash by
30 per cent in a single day.
“I invested about Won19m ($16,000)
about five years ago when oil prices
were around $40-$50,” she said. “I
thought that I could easily make money
because almost everyone at that time
was expecting oil prices to go up.”
She added that her principal is nowworth about 60 per cent less compared
to when she first invested. Ms Song did
not wish to provide the name of the
product she invested in or the company
that issued it.
Analysts have previously warned that
the derivative products favoured by
South Korean investors can worsen
market turbulence during sudden
downturns.South Korea’s financial watchdog is
investigating whether there has been
any “illegality involved” in the sale of
such products, according to a person
with direct knowledge of the matter.
“We are looking closely into this as a
drop in oil prices increases the chance of
investors suffering losses from these oil-
linked [notes].”
Many investors have yet to cash out,
instead hoping for an oil price recovery
before their products mature.
A sudden jump in redemptions could
cause problems for issuers, said Tae
Jong Ok, an analyst at Moody’s who has
raised concerns over risk-taking at
South Korean securities companies. “If
there is a significant cancellation of
these products, the securities compa-
nies may be faced with very short-term
liquidity issues.”
A spokesperson forMirae Asset
Daewoo Securities, a Seoul brokerage,
said the group had received “a lot of
inquiries from investors about what
they should do with their oil-linked
investments” after Monday’s price col-
lapse. “We have been advising them to
hold the products until they mature
because oil prices could rebound.”Derivatives
South Korean retail investors in exotic
investment products hit by crude crash
‘I thought I could easily
make money because
almost everyone wasexpecting oil to go up’
The losses for bonds come after Opec
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OW E N WA L K E R A N D R O B E RT S M I T H
Three weeks into the turmoil afflicting
financial markets, the strain on funds is
starting to show.
London-basedH2O Asset Manage-
ment as suffered one of the harshesth
blows. In volatile trading on Monday, its
flagship Multibonds fund lost 20 per
cent of its value on bad bets, according
to data releasedyesterday.
The bonds and currency strategy has
lost 40 per cent since its peak last
month, choppingwhat was a €5.7bn
fund just weeks ago to €3.5bn now.
Ina letter n Tuesday, H2O informedo
investors of the “surprisingly large”
losses. “We have experienced such cri-
ses in the past,” the asset manager said.
“We know that the important thing is
not to regret getting caught... but to
manage the exit well.”
Aside from the strain ofmarket ruc-
tions, asset managers are concerned
that H2O is unlikely to be the last to
report grim numbers incoming weeks.
Many aresteeling themselves for big
outflows following the recent financial
turbulence, which will test the indus-
try’s resilience after a long bull run.
“It is virtually impossible to identify
the next domino to fall but one thing
seems certain, they will continue to fall,”
Scott Minerd, Guggenheim’s chief
investment officer, said in a note to
clients. Quoting Winston Churchill, he
warned: “This is not the end. It is not
even the beginning of the end. But it is,
perhaps, the end of the beginning.”
Global equities have now lost about 16
per cent of their value since the
February peak whilegovernment bonds
have soared, pushing their yields down
to record lows. Corporate debthas been
pummeled and several fund managers
warn that his could prove to be the epi-
centre of any aftershocks.
This has unravelled what was initially
a promising start to 2020 for asset man-
agers. After robust inflows at the start of
the year, equity funds suffered $42bn of
withdrawals in the two weeks to March
4, while credit funds lost over $20bn,
according to EPFR. Given that fund
flows tend to lag behind returns, those
numbers are expected to grow.
As a result, US asset management
company stocks have tumbledmore
than a quarter this year,putting them in
bear market territory. In Europe,
Amundi’s stock is down 20 per cent,
Standard Life Aberdeen as dropped 21h
per cent andSchroders as lost 28 perh
cent of its value.Natixis, which owns
H20, has fallen more than 40 per cent.
John Foley, the chief executive ofM&G, argued some choppiness was
inevitable. “If you are a pure-play
mutual fund manager, life will be vola-
tile with periods of inflow followed by
periods of outflows,” he said. “The asset
management business is somewhat
challenged, but it’s not dead.”
Others in the industry are worried
about the wider ramifications that
major outflows could have on markets
that remain fragile. “One of the risks in
turbulent market conditions is being
forced to sell assets to meet liquidity
needs,” said UBS Global Wealth Manage-
ment chief investment officer Mark
Haefele — a nod to the risk that drops in
one market can almost automatically
trigger drops elsewhere.
Some point tostrain in corporate
debt, which tradesless frequently than
equities. That means it can be difficult
to get trades done at times of turbulence
and even modest selling can produce
outsized declines, in turn worsening the
sell-off and leading to further outflows.
This has been a concern since thecri-
sis and the corporate bond market haslargely weathered every test of its resil-
ience. When Third Avenue, a US money
manager, had to freeze redemptions
from its struggling junk bond fund in
late 2015 it briefly caused mayhem but
the turbulence eventually passed.
Some fund managers said outflows
had not yet forced them to sell underly-
ing assets.
“There will probably be days where
we will see one-sided outflows but so far
we have seen flows be relatively steady,”
said John Yovanovic, global head of high
yield at PineBridge. “We haven’t seen
panic outflow days so far in credit.”
But the recent poor performance of
credit markets could prove to be a test.
Investment grade corporate bonds
had until recently benefited from their
greater safety. But an exchange traded
fund tracking the asset class lost 2.4 per
cent on Monday, the biggest one-day
drop since the financial crisis.An ETF
that tracks lower-rated “junk” bonds
has tumbled 8 per cent since the spread-
ing coronavirusbegan to shake mar-
kets. Debt issued by US shale companies
is of particular concern — already
$110bn of energy bondsare distressed.
Craig Nicol, a Deutsche Bank strate-
gist, argues it could even prove to be a
“Minsky Moment” for junk bonds, a ref-
erence to the late economist Hyman
Minsky’s theory that stability breeds
complacency and that eventually leads
to a sudden crash.
“Five years ago, the high-yield market
‘only’ had falling commodity prices to
deal with — this time round, liquidity is
already a huge concern following the
impact of the coronavirus selling,” Mr
Nicol wrote in a report, warning that an
“impending liquidity crisis” would
probably cause losses on junk bonds to
spiral higher.
Additional reporting by Siobhan RidingActive manager’s soured bets
herald a test of the industry’s
resilience after strains increase
‘It is
virtuallyimpossible
to identifythe next
domino tofall —but
they will fall’Wall Street
traders have
had to cope with
big losses for
equities since a
February peak
Richard Drew/APAsset management. olatilityV
Funds braced for outflows as
H2O points to ructions ahead
TO M M Y ST U B B I N GTO NThe UK government announced its
biggest annual borrowing plan in eight
years yesterday as Prime Minister Boris
Johnson’s government turns to bond
markets to fund its spending spree.
But investors were unfazed by the
prospect of a deluge of new gilts — with
many having expected an even bigger
rise in issuance with borrowing costs
close to historic lows.
Rishi Sunak, the chancellor,
announced £30bn stimulus packagea
in his first Budget to counter the fallout
of the coronavirus outbreak, marking
the end of a decade of austerity policies
with significant increases in capital and
day-to-day spending.
To finance the largesse, the UK’s debt
management office announced after the
chancellor’s speech gilt sales of £156.1bn
in the 2020-21 fiscal year, the highest
total since 2012-13. Analysts’ average
forecast was £166bn.
“Everyone is scratching their heads
over why it’s such a low number,” said
Theo Chapsalis, head of UK rates strat-
egy at NatWest Markets. “Sunak spent
an hour telling us about all these give-
aways and we are puzzled that we don’t
see it in the issuance figures.”
Gilt yields had risen ahead of the
Budget — reflecting lower prices — as
investors prepared for a bigger jump inborrowing. But they fell back on the
issuance announcement with the 10-
year bond yield trading slightly lower at
0.26 per cent.
The UK’s main benchmark borrowing
cost remains not far above Monday’s
all-time low of 0.07 per cent — reached
during Monday’s record-breaking
global bond rally.
Markets took the jump in issuance in
their stride because the economic
impact of the coronavirus is likely to
keep fuelling appetite for safe assets,
according to Mike Riddell, head of
UK fixed income at Allianz Global
Investors.
After an emergency interest rate cut
to a record low of 0.25 per cent earlier
yesterday, Mr Riddell said there was a
good chance that the Bank of England
would resume its bond-buying stimulus
programme later in the year.
“I think it’s inevitable the borrowing
number will rise during the year,
once we see the economic impact of
coronavirus coming through and
continued need for [a] fiscal response,”
said Mr Chapsalis.
Rating agency Moody’s warned about
the “deterioration” of the UK’s public
finances following the Budget.
Mr Sunak’s spending pledges would
support economic growth but high-
lighted the “ongoing difficulty in mean-
ingfully reducing the UK’s gross general
government debt burden from its
current high levels”, said Sarah Carlson,
a Moody’s senior vice-president.Fixed income
Buyers of gilts
unfazed by
UK spending
promises
Moody’s warned about
the ‘deterioration’ of the
UK’s public financesfollowing the Budget
Asset managers’ resilience tested after long bull run
Index and share prices in terms (rebased)Source: Refinitiv* S&P Asset Managers & Custody Banks index Jan MarUS asset managers*
Amundi
Standard Life Aberdeen
SchrodersMARCH 12 2020 Section:Markets Time: 3/202011/ - 17:48 User:stephen.smith Page Name:MARKETS1, Part,Page,Edition:EUR , 19, 1