Tremors: The Evolution Of A Short High Yield Strategy by The TradeX Group
The current high yield (HY) bubble can be thought of as an impending earthquake that is severe in magnitude and warning local inhabitants with foreboding tremors. We have been discussing the state of the HY market with investors for approximately two years now, shooting up flares and ringing alarms, like these communications in December 2013 and March 2014 (before and when our short strategy launched). The basic investment thesis has been that there are hundreds of companies that have had near unfettered access to capital markets due to unprecedented easy-money policies. Many of these companies did not merit this access, but nevertheless it was still cheap and easy for them to find refinancing or to issue new debt. These companies probably knew that at some point capital markets would become much harder and more expensive to access. The tremors are now much closer to each other and carry much more force, as we wind down a year that will result in the first annual HY loss since 2008. The “worst-of-breed” HY companies that we target are becoming easier to find, because there are so many of them. In this blog, we will review the evolution of a short high yield bond strategy in recent years.
City-life is bustling – 2009 to 2012: The Financial Crisis is over and companies that barely made it out of 2008 have licked their wounds. Helicopter Ben is QE’ing like crazy and capital markets are open for business. High yield companies have access and can raise large amounts of low-cost debt. What do they do with it? They extend their Ponzi-schemes by refinancing prior debt, by paying out dividends, by initiating expensive share buy-back plans and by making ill-advised acquisitions and LBOs. In CCC’s, less than 10% of new bond issuance is used for corporate purposes, CAPEX or project finance.
Seismic activity deep underground – 2012 to 2014: CCC’s that hung on in 2008