HY Investors Break Free From Jail Of Tight Spreads

July 30, 2007

A thumbs up to Bill Gross, bond portfolio manager and managing director at PIMCO, who like others on the buy side of the market is heralding the newly established unity among bondholders.

Gross, who made his views known in his August 2007 investment outlook titled "Enough is Enough," is tough on bond investors for their previous inaction, saying they have resembled "passive owls for years if not decades." (One can only assume that he includes himself in this criticism.)

For those of you who haven't read the piece, his brutal (though thoroughly entertaining) assessment of the high yield market goes on to use ever more colorful metaphors, such as this one: "Covenant-lite deals and low yields were accepted by money managers as if they were prisoners in an isolation ward looking forward to their daily gruel passed unemotionally three times a day through the cellblock window. Here, take this,' their investment banker jailers seemed to say, and be glad that you've got at least something to eat!'"

While I wouldn't go so far in my criticism of bondholders, especially since I'm not one, I do agree with Gross's basic thesis that the buy side must take some responsibility for letting the market get out of control the way it had up until a few weeks ago. I know, I know. It's the hedge funds - or in the case of the loan market, the hedge funds and the CLO managers - who swoop in to buy up any old deal, driving spreads ever tighter, then leap out when the going gets rough. And of course investors have money they need to put to work.

The thing is, though, that when they finally were pushed to the edge, with subprime and covenant lite and PIK toggles and everything piling up around them, investors did finally say "enough is enough." So why not take that step a little sooner? Why wait?

Probably because investors are, first and foremost, human. And human beings have an inherent tendency to procrastinate until a situation gets spectacularly bad before we act.

So now, Gross is happy. Bondholders have acted and maybe in a sense they have even banded together. But it's easier to unite - whether through an outright movement or a mass epiphany - when the situation is so clearly out of control. Will that alliance continue once the market stabilizes? Maybe for a while. But human as we all are, with any number of other inherent tendencies, including the repetition of patterns, it likely won't last forever.

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