Managers of Canadian high-yield bond funds are seeking a haven from a selloff in the country's biggest export, in the debt of everything from property developers to a company that produces elevator music to the national airline.
The top performers in the fourth quarter are developer Brookfield Residential Properties Inc. and Mood Media Corp., the background-music provider that acquired Muzak Holdings LLC in 2011, according to Merrill Lynch. Air Canada's bonds are beating global peers including United Continental Holdings Inc. and Qantas Airways Ltd., up 10.8 per cent this year versus an average gain of 8.3 per cent in another Merrill Lynch index of air-transportation debt.
"Right now, everyone owns too much energy," said Geof Marshall, who oversees about $9-billion of high-yield bonds at CI Investments Inc. The firm has a "good-sized holding" of Air Canada bonds, while its Signature High Yield Bond Fund has half the energy-company weighting recommended by benchmark indexes, he said.
Investors are seeking alternatives to oil-related issuers after OPEC's refusal to ease a supply glut pushed prices to a five-year low this week and cast doubts over the survival of smaller producers that borrowed heavily to fund development. Canada's bond market is more skewed toward oil than either Europe or the United States, triggering losses of 20 per cent in the past month on the least-creditworthy energy explorers.
With pressure on them to meet annual return targets at the end of the year, investors can't afford to wait for a recovery in oil prices.
"There's a window-dressing effect around year-end as well where people don't want to have that kind of paper," Martin Fridson, a New York-based money manager at Lehmann Livian Fridson Advisors LLC, who started his career as a corporate-debt trader in 1976, said in a telephone interview earlier this week. "That could precipitate more selling. Diversifying into Europe makes sense."
Junior-ranking debt of U.K. banks that were nationalized during the credit crisis is poised to gain as the banks replace pre-crisis debt with new types of capital, said Mr. Marshall at CI. "Some of our biggest positions are Lloyds [Banking Group PLC] and Royal Bank of Scotland [Group PLC]," he said.
Amaya Gaming Group Inc., a supplier of betting equipment and systems, and Air Canada are among Mr. Marshall's other major Canadian holdings. Air Canada received a ratings upgrade from Moody's Investors Service to B2 from B3 on Sept. 17, which cited a focus on cost-cutting. Bondholder sentiment has also been buoyed by the airline's announcement in January that its Canadian pension plan, which had a deficit of $3.7-billion as of January, 2013, ended the year with a surplus.
Energy companies make up more than 40 per cent of the Merrill Lynch Canada High Yield Canadian Issuers Index and 28 per cent of the debt of Canadian issuers of U.S. high-yield debt.
Connacher Oil & Gas Ltd. led November losses in Merrill Lynch's U.S. High Yield Canadian Issuers Index, with the debt of the oil sands producer posting a 22-per-cent decline. Connacher said earlier this week it hired an adviser to review its liquidity and capital options. The next worst-performer was Baytex Energy Corp. with a 15-per-cent drop since Nov. 3, followed by Calfrac Well Services Ltd., down about 13 per cent, and MEG Energy Corp. and Jupiter Resources Inc., both with losses of 12 per cent.
Calgary-based Connacher, along with MEG, Athabasca Oil Corp. and Southern Pacific Resources Corp., were identified by Standard & Poor's in an Oct. 28 report as having a break-even cost above $80 (U.S.) a barrel.
"Whole swaths of the credit markets are at risk with oil this low," Anthony Peters, a broker at Swiss Investment Corp. in London, said in a note to clients