When I managed the Sunkist pension fund in the late 90s, we had several really good distressed debt managers in our portfolio. I personally selected each one after a few very rigorous interviews because I wanted to make sure they were the right fit. Patience is a common quality of these managers. They performed exceptionally well during a time of high growth and some instability. The destabilizing events included the rise of the Internet, Long-Term Capital Management, a Russian crisis, an Asian market crisis, Y2K fears, and the dot.com bubble.
There is a general belief that bets on high yield come after a recession is over, and the worst time to bet on distressed debt is going into a recession. It is highly unlikely our economy is heading toward a train wreck, but if the Fed growth estimates for 2015 are too high, then it may feel like one.
The destruction of an entire industry, which has a slew of high yield debt, is taking its toll. I am talking about the coal industry. Patriot Coal (PCXCQ) and James River Coal (JRCCQ) went bankrupt. Arch Coal (ACI), Walter Energy (WLT) and Alpha Natural Resources (ANR) are on death watch. Peabody Energy (BTU) and Cliffs Natural Resources (CLF) are making new multi-year lows. The Environmental Protection Agency and the current White House have their eyes set on eliminating this important energy resource for whatever reason. Many of these companies are selling paper at $0.30 to $0.50 on the dollar, ripe for the picking of distressed managers, if these companies do come back around.
For the most part, high yield debt has been a great place to get return over the last few years. It has been a 'safe haven,' as long as the economy stays upright. If something changes, and things cool off too much, then these bets will not seem all that easy. The charts and technical indicators are not yet a reason for concern, but a further drop is going to raise some worries.
