Big investors pare energy junk bond holdings after big rally

Wed Aug 3, 2016 1:16am EDT
 
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By Devika Krishna Kumar and Jennifer Ablan

NEW YORK (Reuters) - Investors in junk-rated energy bonds, who have made a mint this year betting on this battered sector, are paring their holdings as oil flirts with sub-$40-a-barrel levels on concerns about a persistent overhang in supply and choppy demand.

Thanks to the two-year slump in the price of oil, energy debt securities yielded a whopping 21 percent in February when crude hit its lowest in over a decade at about $26. That brought in opportunistic buyers who watched prices rise, pushing yields to around 9.5 percent now, a level that these investors see as overvalued relative to oil's weakening price.

Energy debt prices have managed to continue to rally even as the price of oil headed lower in July, as investors believed that the bankruptcies that resulted from the two-year slump were largely behind the market.

U.S. crude futures CLc1 settled on Tuesday below $40 for the first time since April, on heightened worries of a crude glut despite peak summer fuel demand. Oil lost nearly 15 percent in July, the biggest monthly loss in a year, triggering liquidation among bond investors.

Other bond investors who benefited from the recent risk-on rally in energy debt are paring holdings, viewing the massive run-up as an opportunity to take profits.

"We're neutral on energy bonds," said Dan Ivascyn, group chief investment officer at bond giant Pacific Investment Management Co, which oversees $1.5 trillion in assets. He said the firm is "cautious after their huge run," having moved to an underweight position in their high-yield holdings.

The BofA Merrill Lynch (BAML) U.S. High Yield Energy Index .MERH0EN posted a return of 26.7 percent from the start of the year through mid-July. Since then, though, the index is slipping, having dropped for 11 days straight, shedding about 3 percent in that period.

About 50 percent of the weight of this index is in double-B bonds, the highest-rated of junk debt. Those spreads are at 4.82 percentage points above comparable Treasury debt, yielding about 6 percent.   Continued...

 
A pump jack is seen at sunrise near Bakersfield, California October 14, 2014. REUTERS/Lucy Nicholson