Rout Continues In Junk Bond Market After 2 Funds Are Liquidated

The gloom deepened in the high-yield debt market on Monday, with bonds issued by dozens of companies losing ground, and concerns mounting about how long the rout will last.

Bonds issued by lower-rated companies such as Dynegy, Charter Communications, Chesapeake Energy and Oasis Petroleum have taken a tumble, as have investment funds that trade in such debt.

"It could get pretty ugly this week," Bank of America strategist Michael Contopoulos said, in an interview with Bloomberg News.

The downturn in the high-yield debt, or junk bond, market has intensified in recent days after two high-yield funds announced they were suspending investor withdrawals, because of losses.

Junk bonds have performed well in recent years, in part because central banks such as the U.S. Federal Reserve have kept interest rates so low. As a result, a lot of investors plowed their money into junk bonds, which pay better but are also riskier.

Now, however, the Fed is poised to raise interest rates, and the flow of money into the sector appears to be reversing.

Meanwhile, concern is building about the slowing global economy, and investors are worried that a lot of companies that borrowed in the junk bond market won't be able to pay back what they owe. Oil and gas companies are especially threatened.

Jeff Tjornehoj, head of Americas research at Thomson Reuters Lipper, told The Wall Street Journal that "investors remained disappointed by returns" in the high-yield market:

"There hasn't been a whole lot of great news as far as the economy or yields. The shocks to the system have more than offset the trickle of good news."

Last week, the U.S. investment firm Third Avenue liquidated its Focused Credit Fund and told investors it was suspending redemptions, meaning investors were temporarily barred from getting their money back. The company fired its chief executive, David Barse.

The hedge fund Stone Lion Capital Partners also said it was barring redemptions from one of its funds.

"The closures highlight an area of growing concern: the impact of investor flows on bond prices and the ability of companies to raise finance," noted The Financial Times. It added:

"High-yield mutual funds, which face the first year of widespread losses since 2008, must return capital on demand. So the risk is that a need to sell bonds to meet redemptions pushes down prices, prompting further fund redemptions."

With so much uncertainty in the market, Lucidus Capital Partners, a high-yield hedge fund, said Monday that it has liquidated its entire portfolio and will return the $900 million it has under management to investors next month.

"The risk is that this is going to cascade into something bigger," Scott Minerd, global chief investment officer at Guggenheim Partners, told Bloomberg News on Friday. As investors worry about getting their money back, 10 to 15 percent of junk bond funds could face high withdrawals, he said.

"If we're going to see contagion, the most vulnerable funds are going to be the ones that are down significantly," said Minerd.