Adam J. Schwartz of Black Bear Value Partners presented his short investment thesis on credit ETFs at Best Ideas 2019.
Thesis summary:
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.
Listen to this session:
slide presentation audio recording
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.
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