I'm coming from the equity side so absorb my ignorance for a second. Why do LPs allocate to junk bonds / high yield credit when the expected returns are seemingly by definition lower than equity? I'm reading Marks latest letter and he talks about buying junk starting in 1978. If your mandate is credit only, then sure you can make lots parsing junk with high yields. But if you're multi asset what is the appeal of junk relative to just a high beta tech equity name? Thank you!
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Hi, I read that letter too, wasn't that around the time when Volcker was hiking the ass outta interest rates? Equity returns were paling in comparison right?
Plus, throughout his letters he seems to like to drive home the point of being at the right places before everyone else (so that there are inefficiencies), doing niche stuff (reading and understanding complex boring bond covenants which no one else wants to read), and pure 'luck' if you will. He was pushed out of his Director of Equity Research role at Citi due to his flounder with the 'Nifty Fifty', was offered a 2nd chance to lead the fledgling bond portfolio at Citi, later exited to lead the bond portfolio at TCW which coincidentally aligned with the time Milken had the pioneer idea to issue high yield. So to answer your question, I think a broader point he tries to illustrate is just that - being a pioneer, not necessarily the attractiveness of the asset classes he chooses to specialize in, nor his special skills within his asset class. If anything, he instructs (in his memos) more with equities as an illustration rather than high yield (his specialty).
Milken himself drew huge success from being the first person to do what he did.
That's why I seriously value Marks over the rest - he's blunt and honest, keeps things simple, doesn't try to attach some 'grand wisdom' to everything he did in hindsight (unlike people like Soros, notably (theory of reflexivity lol, no one knows if he cooked that up in hindsight or not) ), recognizes the futility in forecasting and trying to know everything with precision because no one can. Very high investment IQ, in other words
HY BBB/BB credit right now trades around a 450-500 I-spread (that’s a 7.5%-8%) unlevered. Add some repo and you have a 13-14%. If you have permanent capital and can sustain marks it’s a pretty great place to allocate Especially at times such as now. There’s even AAA structured credit around a 200 spread (6%) unlevered, while equities are 7-8% a year.
This is really insightful!
And sorry for being daft but what do you mean by Repo? Is it back-leverage?
Repurchase agreement. Liquid, reliable, short-term financing used as bridge financing by most and thus can be used as leverage by HF to jack up returns to the tits. Not sure if it counts as back leverage in your book, but I think it's not
It's like asking why would a GP allocate to emerging market or alts or any other asset class. GPs such as endowments or pensions want a diversity of assets and risk profiles. Not all GPs are trying to shoot the lights out for returns, it doesn't fit the 4-7% need for their return requirements. They may supplement a small single digit allocation for HFs for diversity. The big trend was endowment allocating north of 20-30% on alts, but as we saw this year, this has come back to bite them. For high yield bonds it's similar to the reasons outlined - you a diversity of returns.
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