Overall, default rates among junk-bond issuers are projected to move about 3 percent next year, according to Moody's Investors Service, up from 2.7 percent in the first 10 months of this year. Barring a surprise, junk defaults will still be well below the long-term average of 4.6 percent. And since most issuers have taken advantage of cheap money to lock in low rates, few junk bonds mature next year, Moody's says.
In an improving economy, aside from the export sector, there isn't much reason for a wider range of companies to run into financial trouble. For example, the BlackRock fund's biggest holding is bonds of hospital chain HCA, which has $28.4 billion of debt, mostly from a leveraged buyout in 2006. HCA has been servicing that debt since, and its earnings before interest, taxes and noncash charges over the first nine months of this year is about three times the interest payments. Unless people have a lesser incidence of getting sick, HCA's bondholders will be repaid on time.
The BlackRock fund's other top holdings include telecom companies like T-Mobile and Sprint and technology giant Cisco Systems, which also don't have obvious macroeconomic challenges. None of its 10 top holdings is debt issued by an energy company.
Third Avenue's failure is a sign of how hard one has to try to run a high-yield fund into the ground. More than half the fund's assets were in bonds rated CCC or lower, the levels where rating agencies think near-term default is highly possible or even likely, or are not rated at all. With junk of all grades representing only about a quarter of the corporate bond market, defaults on investment-grade debt are very rare — none have happened in the last year.
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There's little sign of any contagion spreading into the exchange-traded funds investors use to bet on diversified high-yield portfolios. Indeed, investors have actually added a net $3.85 billion to high-yield funds this year, raising the category to more than $44 billion, according to FactSet. The biggest withdrawals have come from a leveraged-loan fund, Invesco's PowerShares Senior Loan Fund, which had lost $1.1 billion, to fall to $4.4 billion in assets, FactSet said.
Leveraged loans, because they are illiquid, are a riskier asset class than most high-yield bonds.