Adam J. Schwartz of Black Bear Value Partners presented his short investment thesis on credit ETFs at Best Ideas 2019.
Investors have unrealistic expectations of their credit ETF holdings. Bond illiquidity underlies an assumption of daily ETF liquidity.
Asset-liability mismatches can lead to painful endings. These structures were not created for illiquid bonds in the event of a large selloff. It is hard to predict how things play out if the market makers lose confidence in the liquidity of the underlying bonds. Indexing illiquid junk bonds or near-junk investment grade bonds with limited legal protections is asking for trouble if the waters start to get rocky.
The “high yield” bonds have a current ~6% annual yield with a loss-adjusted yield closer to ~3-4% and possibly 0-2%. When high-yield prices inevitably decline and there is a need for liquidity, those structures may fall apart.
The same argument largely holds true with investment-grade ETFs. One-half of the holdings are BBB, barely above junk status.
The payoff could be asymmetric and provides a unique way to profit outside the norms of typical long investing.
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About the instructor:
Black Bear Value Partners is managed by Adam J. Schwartz who has 16 years of buy-side investment experience in a variety of themes including equities, structured products, corporate credit and capital structure arbitrage. Prior to founding the Investment Manager, Adam served as a Director and senior member of the investment team at Fir Tree Partners, a $13BB peak-AUM multi-strategy investment manager (2007-2015). Prior to joining Fir Tree, Adam was an Investment Analyst at LibertyView Capital Management, a multi-strategy investment fund within Lehman Brothers, as well as at Kore Advisors, an investment fund seeded by Paloma Partners. Adam received his BS and MS with a concentration in Accounting from Washington University in St. Louis.