What It Feels Like to Be a Junk Bond Contrarian
J.P. Morgan Asset Management’s Bill Eigen says now is the best time to buy high-yield bonds since 2009.
By Julie Segal
Bill Eigen (Photo credit: Michael Nagle/Bloomberg)
Most investors tell stories about being
the odd man out, the contrarian, long after their bold and messy moves have paid
off. Their retrospective tales often get taller once the market has recovered and the
critics have been silenced.
But sometimes it’s true. William Eigen
III, a veteran bond manager who is part
owner of several auto repair shops and
a restorer of classic American cars like
Chevrolet Camaros, is currently scooping
up high-yield bonds, even as investors
race the other way and abandon the asset
class in record numbers. Eigen, who runs
$25 billion in opportunistic credit funds
at J.P. Morgan Asset Management, says
he is the most excited he has been about
lower-rated corporate bonds since the beginning of 2009.
High-yield fund outflows are creating
huge contrarian opportunities for intrepid investors like Eigen. For instance, State
Street Global Advisors’ high-yield exchange-traded fund had lost about 9 percent of its assets, or $1 billion, by December 10, whereas junk bond funds overall
saw outflows of $9.4 billion in November
and December, according to the Investment Company Institute. As recently as
October, flows into junk funds were near
records. In September Frontier Communications Corp. issued the fifth-largest highyield deal in history. Through December
14, high-yield was down 5.15 percent; two
weeks prior, the category was down only
1.44 percent.
“If you’re going to slam a market with
that much supply, it’s going to break
down,” says Eigen. He adds that the highyield market remains healthy, with an av-
erage dollar price for the JPMorgan High
Yield index of 86, and interest coverage
and net debt to earnings before interest,
taxes, depreciation and amortization
(ebitda) is much higher than in the past
bear market. The average dollar price was
in the low 80s before the Christmas holiday. Though defaults remain at 2 percent,
the market is pricing in an 8 percent to 9
percent default rate, he says. “You could
default the entire energy sector and metals and mining at 30 cents on the dollar,
and you couldn’t get close to that,” he
laughs. Eigen is on a roll: “A true bubble
was ’07, ’08. Issuance was rotten to the
core, you could put a dead squirrel carcass
in a pizza box, and it would get oversubscribed. You don’t have that now.”
Eigen, who learned about cars from
his father, an Army mechanic, is used to
speeding around the track counterclockwise. After rising through the ranks at Fidelity Investments and growing the firm’s
then-fledgling Strategic Income Fund and
multisector institutional products to $10
billion, he quit in 2005. Eigen was using a
still fairly rare strategy at the time: moving
money between different fixed-income
asset classes, depending on his views of
the market. But he felt he couldn’t protect his investors anymore because risk
premiums were tight, rates were low, and
the fund’s mandate was to be fully invested at all times. Instead, he wanted to run
an absolute-return fund, which would
do well in any market environment, and
get out of the business of relative returns,
measuring himself merely against the
fund manager up the street or a random
benchmark.
Eigen wanted to preserve investors’
money using shorting and hedging techniques. He first moved to hedge fund firm
Highbridge Capital Management and
then in 2008 to J.P. Morgan, which owns
a stake in Highbridge. His J.P. Morgan
funds still move between different asset
classes, but he can also do relative-value trades — both long and short — and
hedge against big declines in prices.
Despite the huge opportunity in highyield, Eigen is frustrated with investors.
“As usual, investors are completely engaging in self-defeating behavior. They buy
when returns are strong and you’re not
getting paid for the risk, and they sell when
it goes down, spreads are wide, and you’re
getting compensated incredible amounts
to own the asset class,” says the fast-talking
Eigen. He spoke to us in an interview punctuated by lots of laughter, a little swearing,
pointed criticism of financial reporting
designed to “scare investors” and to-thedecimal-point statistics on gross domestic
product and leverage ratios.
High-yield has had a tough year. Yields
on U.S. junk bonds went from 7.43 percent
in early November to 8.89 percent as of
December 18, according to Credit Suisse.
Third Avenue Management spooked the
market when it took the rare step of preventing its investors from cashing out of
its Focused Credit Fund in early December. Although the fund is not a high-yield
bond fund — it is filled with highly illiquid
distressed securities — investors took it as
a sign of more problems to come.
Eigen says his market experience illustrates how investors maim themselves by
buying and selling at the absolute worst
times. In 2007 and ’08 the J.P. Morgan Income Opportunity Fund, which he now
manages, didn’t own any high-yield, even
though investors were racing to buy it.
“Now here we sit with great valuations, but
people would rather buy a ten-year Treasury at 2 percent,” he says, adding that he
expects a 20 percent return on high-yield
from just collecting interest payments and
150 basis points of spread tightening.
The J.P. Morgan Income Opportunity
Fund has about 46 percent in lower-rated credit, including synthetics. Cash has
come down from about 65 percent to 30
percent, and Eigen is still spending. He
may ultimately bring the junk allocation
to 55 percent or 60 percent. The fund also
has hedges in place, including shorting
investment-grade, some emerging markets debt.
“When I buy high-yield, I always feel
like I’m the only one, because I’m typically
buying when there is blood in the water,”
he says. His moves do result in lumpy returns. In 2009 the fund was up almost 20
percent, because he had gotten great buys
in 2008 and early 2009. He was up a little
more than 8 percent in 2012 because of the
setup he got in 2011 during the European
debt crisis.
Though he’s perfectly happy buying
what others are throwing out, he does
suffer some criticism. “So much venom is
being directed my way right now,” he says.
“Last year, June 14, when we were at maximum cash, I was screamed at for not putting the cash to work in yieldy products.
Now I’m getting yelled at for spending
my cash.” Criticism makes many portfolio managers cower. It’s also the logic behind much of behavioral finance: that humans are captives of their minds’ wiring.
We were once rewarded for following the
crowd that was running from the predator. But it’s damaging behavior in the investment world.
Eigen says if he cared about career risk
— the damage bold decisions can wreak
on job prospects — he wouldn’t be able to
add to an asset class that is going straight
down. “I do it because I love it,” he says.
Quitting Fidelity when he ran a star fund
suggests he’s not always thinking about
his career first.
But he’s also confident he’s doing the
right thing. “I’m seeing IRRs [internal
rates of return] of 15 to 25 percent all over
the place in high-yield. In 2014, that was
5 to 8 [percent],” he says. Here’s a revelatory statistic: This week the yield on the
Merrill Lynch U.S. High Yield Master II index, which is filled with highly liquid junk
bonds, was 8.1 times the yield of the Merrill Lynch Global Government Bond Index
II, which includes Europe, the U.S. and
some emerging markets like Indonesia
and Brazil. The record is a little more than
9 during the financial crisis. Investors are
getting paid eight times as much to own
U.S. high-yield in a growth environment
with 2 percent defaults than they are to
own a globally diversified basket of government bonds from all over the world.
Every time the yield gets close to where
it is now, high-yield subsequently outperforms. “But you gotta kick everyone out of
the club before it’s going to get good,” he
concludes.
NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE
This article has been printed in its entirety with permission from Institutional Investor.
The article is to be used for informational purposes only. This material does not contain sufficient information to support an
investment decision and the recipient should ensure that all relevant information is obtained before making any investment.
It is not to be relied upon for legal, investment
or tax advice. Please speak to a financial professional for more detailed explanations.
This article must be distributed with the J.P. Morgan performance and disclosure pages.
REP-JunkBd
Reprinted from the January 2016 issue of Institutional Investor Magazine. Copyright 2016 by Institutional Investor Magazine. All rights reserved.
For more information call (212) 224-3675
NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE
Data as of December 31, 2015
J.P. Morgan Asset Management
JPMorgan Strategic Income Opportunities Fund
Total returns
Average annual total returns
Since
inception
10/10/2008
4.76
4.25
5.03
5.26
0.12
N/A
Performance at NAV (%)
Latest QTR
YTD
1 yr
3 yrs
5 yrs
A Shares
-1.12
-2.37
-2.37
0.07
1.50
C Shares
-1.26
-2.84
-2.84
-0.44
1.00
Select Shares
-1.14
-2.20
-2.20
0.30
1.76
Barclays U.S. Universal Index
-0.55
0.43
0.43
1.51
3.46
BofA Merrill Lynch 3-Month U.S. Treasury Bill Index
0.03
0.05
0.05
0.05
0.07
Lipper Alternative Credit Focus Funds Index
-1.19
-2.54
-2.54
-0.21
N/A
With sales charges (%)
A Shares with 3.75% max. sales charge
-4.82
-6.06
-6.06
-1.20
0.73
4.20
C Shares with 1.00% max. CDSC
-2.26
-3.84
-3.84
-0.44
1.00
4.25
Lipper Index since inception returns are as of month-end. The performance quoted is past performance and is not a guarantee of future
results.
Yields (%)
30-day SEC yield
30-day SEC yield (unsubsidized)
Calendar-year returns (%)
A Shares at NAV
Barclays U.S. Universal Index
BofA Merrill Lynch 3-Month U.S. Treasury Bill Index
Lipper Alternative Credit Focus Funds Index
A Shares
3.93
3.65
2011
-0.28
7.40
0.10
N/A
C Shares
3.57
3.39
2012
7.82
5.54
0.11
8.88
2013
2.78
-1.35
0.07
1.26
Select Shares
4.33
4.19
2014
-0.14
5.56
0.03
0.70
2015
-2.37
0.43
0.05
-2.54
The performance quoted is past performance and is not a guarantee of future results. Mutual funds are subject to certain market
risks. Investment returns and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than original cost. Current performance may be higher or lower than the performance data shown. For
performance current to the most recent month-end, please call 1-800-480-4111.
Annual operating expenses
Expense cap expiration date
Expense cap (%)
Total annual Fund operating expenses (%)
Fee waivers and/or expense reimbursements (%)1
Net expenses (%)1
A Shares
6/30/2017
1.00
1.27
(0.26)
1.01
C Shares
6/30/2017
1.50
1.74
(0.23)
1.51
Select Shares
6/30/2017
0.75
0.97
(0.21)
0.76
1The
Investment Advisor, Administrator and Distributor (the "Service Providers") have contractually agreed to waive fees and/or reimburse
expenses to the extent that Total Annual Operating Expenses (excluding Acquired Fund Fees and Expenses, dividend expenses relating to
short sales, interest, taxes, expenses related to litigation and potential litigation, extraordinary expenses and expenses related to the Board
of Trustees’ deferred compensation plan) exceed the expense cap of the average daily net assets through the expense cap expiration date.
This contract continues through that date, at which time the Service Providers will determine whether or not to renew or revise it.
Top ten holdings (%)2
385 First Avenue LLC, 5.73%, 10/1/2017
787 11th Funding LLC, 5.19%, 1/9/2017
U.S. Treasury Note, 2.25%, 11/15/2025
Apple, Inc., 0.64%, 5/6/2019
DoubleTree, 6.23%, 6/1/2017
Hyatt Centric Funding, LLC, 6.22%, 10/1/2017
Sprint Communications, Inc., 9.00%, 11/15/2018
CIT Group, Inc., 5.25%, 3/15/2018
First Data Corp., 5.75%, 1/15/2024
TOTAL
1
Percentage
1.3
1.1
1.0
0.7
0.4
0.4
0.3
0.3
0.3
6.4
2The top 10 holdings listed reflect only the Fund's long-term investments. Short-term investments are excluded. Holdings are subject to
change. The holdings listed should not be considered recommendations to purchase or sell a particular security. Each individual security is
calculated as a percentage of the aggregate market value of the securities held in the Fund and does not include the use of derivative
positions, where applicable.
Sector allocation (%)*
Agency MBS
Bank Loans
Cash
CMBS/ABS
Commercial RE
Credit RV
EMD/Sovereign
High Yield
Invest Grade Corp
Non-Agency MBS
Other
2.1
5.5
25.3
1.5
5.2
8.1
0.7
34.7
0.9
9.8
6.3
*
Due to rounding, values may not total 100%.
Portfolio statistics
Inception date
Investment minimum
Fund number
CUSIP
A Shares
10/10/2008
$1,000
3841
4812A4385
C Shares
10/10/2008
$1,000
3842
4812A4377
Select Shares
10/10/2008
$1M
3844
4812A4351
Contact JPMorgan Distribution Services, Inc. at 1-800-480-4111 for a fund prospectus. You can also visit us at
www.jpmorganfunds.com. Investors should carefully consider the investment objectives and risks as well as charges
and expenses of the mutual fund before investing. The prospectus contains this and other information about the
mutual fund. Read the prospectus carefully before investing.
RISKS ASSOCIATED WITH INVESTING IN THE FUND:
The Fund's fixed income securities are subject to interest rate risk. If rates increase, the value of the Fund’s investments generally declines.
Ordinarily the Fund will invest no more than 75% of its total assets in credit securities.
The Fund may invest in securities that are below investment grade (i.e., “high yield” or “junk bonds”) that are generally rated in the fifth or
lower rating categories of Standard & Poor's and Moody's Investors Service. Although these securities tend to provide higher yields than
higher-rated securities, there is a greater risk that the Fund's share price will decline.
The Fund has the ability to invest 100% of its total assets in high yield securities.
International investing involves special risks, including economic, political, and currency instability - especially in emerging markets. The
Fund's investments in emerging markets could lead to more volatility in the value of the Fund's shares. The small size of securities markets
and the low trading volume may lead to a lack of liquidity, which leads to increased volatility. Emerging markets may not provide adequate
legal protection for private or foreign investment or private property.
The Fund may engage in short sales. There is no guarantee that the use of long and short positions will succeed in limiting the Fund's
exposure to domestic stock market movements, capitalization, sector swings or other risk factors. Investment in a portfolio involved in long
and short selling may have higher portfolio turnover rates. This will likely result in additional tax consequences. Short selling involves certain
risks, including additional costs associated with covering short positions and a possibility of unlimited loss on certain short sale positions.
The Fund may invest in futures contracts and derivatives. Many derivatives create leverage that can cause the Fund to be more volatile than
it would be if it had not used derivatives.
The Fund's investment in equity securities may rise or fall because of changes in the broad market or changes in a company's financial
condition, sometimes rapidly or unpredictably. When the value of a fund's securities goes down, an investment in a fund decreases in value.
The Fund will invest no more than 50% of its total assets in foreign and emerging markets securities.
The Fund has an absolute-return orientation, which means that it is not managed relative to an index.
2
INDEXES DEFINED:
The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for
a full month. Each month the index is rebalanced and the issue selected is the outstanding Treasury Bill that matures closest to, but not
beyond 3 months from the rebalancing date. The performance of the index does not reflect the deduction of expenses associated with a
fund, such as investment management fees. By contrast, the performance of the Fund reflects the deduction of the fund expenses, including
sales charges if applicable. An individual cannot invest directly in an index.
The Barclays U.S. Universal Index represents the union of the U.S. Aggregate Index, the U.S. High-Yield Corporate Index, the 144A Index, the
Eurodollar Index, the Emerging Markets Index, and the non-ERISA portion of the CMBS Index. The performance of the index does not reflect
the deduction of expenses associated with a fund, such as investment management fees. By contrast, the performance of the Fund reflects
the deduction of the fund expenses, including sales charges if applicable. An individual cannot invest directly in an index.
The performance of the Lipper Alternative Credit Focus Funds Index includes expenses associated with a mutual fund, such as investment
management fees. These expenses are not identical to the expenses charged by the Fund.
Total return assumes reinvestment of dividends and capital gains distributions and reflects the deduction of any sales charges, where
applicable. Performance may reflect the waiver of a portion of the Fund's advisory or administrative fees and/or reimbursement of certain
expenses for certain periods since the inception date. If fees had not been waived and/or certain expenses were not reimbursed,
performance would have been less favorable.
J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses
include, but are not limited to, JPMorgan Chase Bank, N.A., J.P. Morgan Investment Management Inc., Security Capital Research &
Management Incorporated, J.P. Morgan Alternative Asset Management, Inc., and J.P. Morgan Asset Management (Canada), Inc.
J.P. Morgan Funds are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of
JPMorgan Chase & Co. receive fees for providing various services to the funds. JPMorgan Distribution Services, Inc. is a member of
FINRA/SIPC.
The article is to be used for informational purposes only. It is not to be relied upon for legal investment or tax advice. Please speak to a financial
professional for more detailed explanations.
©JPMorgan Chase & Co., January 2016
PS-SIOF
NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE