European Bonds Lure U.S. Bargain Hunters

Europe's sovereign-debt crisis has sent many portfolio managers fleeing the region. But some intrepid U.S. investors are venturing across the pond to snap up corporate bonds at cut-rate prices.

Some are buying junk-rated bonds of European companies. Others are taking advantage of a growing price gap between European and U.S. bonds of international companies such as Levi Strauss and Hertz Global Holdings. And some even say there is money to be made in debt of Greek banks.

"It's only every once in a while that you have an opportunity like this," says Ming Shao, a director at DuPont Capital Management, which manages $10 billion of fixed-income investments, mostly for parent company DuPont.



Mr. Shao says bonds became so cheap in October that he bought debt of European companies, choosing bonds that were secured by company assets, as well as euro-denominated bonds of international companies. A longtime mortgage-bond trader, Mr. Shao also just bought debt of Greek banks backed by mortgages, known as covered bonds, for around 60 cents on the dollar. Covered bonds are considered relatively safe because they are backed by mortgages and guaranteed by the banks.

Mr. Shao has increased DuPont's exposure to European bonds by about 5% since September, likening the selloff to similar troubles in credit markets in 1998, 2003 and 2008, times that ended up being good moments to buy.

Investors are buying—despite the obvious risk that Europe falls into a recession or a major country defaults on its debts—in large part because they are so hungry for investments that offer any kind of yield. With interest rates in the U.S. near record lows, investors are searching farther afield, and are often willing to take on more risk.

Investor demand is strong enough that some junk-rated European companies are even selling new bonds. While those deals command high interest rates to compensate for the added risk of future turmoil, the fact that low-rated companies can sell bonds at all demonstrates the willingness of investors to separate the fortunes of governments from their corporate sectors.

French auto-parts maker Faurecia on Thursday raised €300 million ($414 million) by selling bonds rated below investment-grade, or double-B. The bonds pay annual interest of 9.5%.

"We knew some seasoned high-yield investors had cash on hand and were adding to their investments because prices had sold off," says Youssef Khlat, head of high yield at Crédit Agricole CIB, which arranged the Faurecia bond. While the announcement of a surprise Greek referendum during the deal's marketing period heightened investor angst about macroeconomic risk, buyers of the bond were able to look through the market turmoil to see the quality of the company, he said.

Swedish cable company Com Hem is seeking to sell €287 million in bonds that will help fund Carlyle Group's leveraged buyout of the company. If Com Hem is successful, it will be the first European company rated triple-C—one of the lowest credit ratings—to raise money in the bond market since May. Representatives of Faurecia and Com Hem declined to comment.

Until recently, buyers had been absent from the European market. New bond sales had dwindled to €1.8 billion in all of the third quarter, according to Standard & Poor's LCD, from an average of €9.5 billion per month in the first half of the year. The buyers' strike coincided with a collapse in corporate-bond prices, reflected in the iTraxx Europe Crossover—a hybrid index of investment-grade and high-yield credit-default swaps—which fell from 100 in August to 86.5 by early October. Since then it is up to 93.

Not all investors are convinced that bond prices have hit bottom. Some are still waiting to buy, anticipating even better bargains in 2012 as the European debt crisis continues to unfold.

Further selling could be triggered by increased corporate defaults caused by economic recession or additional political shocks, such as an erosion of the European currency union, says Richard Hurowitz, co-founder of Octavian Advisors LP, a $1 billion hedge fund that specializes in international investments.

But Jame Donath, a portfolio manager at Karsch Global Credit, says he is buying now, even though he suspects there will be more bargains to come. Karsch, which is an active investor in European bond and loan markets, began buying some junk-rated debt in September and October after many European banks and investors had sold out to cut risk and raise cash.

"A lot of babies got thrown out with the bathwater," Mr. Donath says. For example, the fund was able to buy debt of a U.K financial-services firm at 88% of face value, and the debt has since risen to about 96%, he says, declining to name the firm.

Investors and banks didn't only dump the debt of European companies this summer. They also sold the euro-denominated bonds of international companies, creating an unusual gap between those securities and bonds sold by the same companies in dollars.

By mid-October, investors could buy euro-denominated bonds of Levi Strauss at an 11% discount to the equivalent dollar bonds, says Sherif Hamid, a strategist at Barclays PLC. Mr. Hamid has been recommending that investors take advantage of the differentials, in part because the foreign-exchange hedging costs are minimal.

They could also buy euro bonds of New Zealand-based Reynolds Group Holdings in October at a 15% discount to the packaging maker's dollar-denominated debt. A spokesman for Reynolds declined to comment.

But, because of the volatility in the European junk-bond market, not everyone who wanted to put the trade on succeeded. By the time some investors were ready to buy Reynolds's euro bonds in late October, prices had already snapped back to within 3% of the company's dollar bonds amid the global market rally.

With just over $150 billion of bonds outstanding, the European junk-bond market is far smaller than the $1 trillion U.S. market and trading is sporadic at the best of times. Since August, the banks that typically deal in European junk have sold off their inventories to reduce risk, meaning that bonds are even harder to find and even small trades worth a few million euros can move prices dramatically.

That is what happened to Venor Capital Management when the $700 million fund tried to buy Reynolds's euro-denominated bonds at their low point, said Venor co-founder Michael Wartell. "We were just a couple of days too late—they just ran up," Mr. Wartell says. "Now we're right back to monitoring where debt is trading."

Given overhanging uncertainty in Europe's economic and political forecast, there will be other opportunities to buy in, Mr. Wartell says. To wit: the difference between Reynolds's euro- and dollar-denominated bonds widened back to 7% last week.

Source: http://online.wsj.com/article/SB10001424052970203733504577021781211872496.html?mod=WSJ_Markets_RightMostPopular