Pimco Wins, Procter & Gamble Loses as Turmoil Spreads (Update1) By Caroline Salas http://www.bloomberg.com/apps/news?pid=20601109&sid=aA3.lujabUSM&refer=home March 6 (Bloomberg) -- Pacific Investment Management Co.'s Total Return Fund, the world's biggest bond fund, has cost investors as much as $55 million because of its growing bet against corporate securities in the past year. Now, Pimco and Mark Kiesel, who oversees $80 billion of company debt at the Newport, Beach, California-based firm, are gaining some redemption as investors flee all but the safest of assets amid concern rising mortgage delinquencies will slow the economy. The extra yield over Treasuries that investors demand to compensate for the risk of default rose the most in a year last week, according to data compiled by Merrill Lynch & Co. ``It's batten down the hatches time,'' said Kiesel, who was so sure the housing market would collapse that he sold his Southern California home last May and moved to an apartment. ``Pimco has obviously been a little bit off on its timing, but we remain pretty convinced we're going to get this right. Profits have been supported by consumer spending thanks to housing going up. As job creation slows, you're going to see credit risk start to be re-priced.'' The $100 billion Total Return Fund began 2006 with 4 percent of its assets in investment-grade corporate bonds, compared with about 23 percent for its benchmark, the Lehman Aggregate Bond Index. The Pimco fund underperformed Lehman's U.S. Credit Index by 0.29 percentage point in 2006. Pimco's fund had 1 percent of its assets in corporate debt as of the end of January. Yield Premiums Bad real estate loans may cause risk premiums to rise from near-record lows, just as they did when hedge fund Long-Term Capital Management blew up in 1998, Enron Corp. and WorldCom Inc. filed for bankruptcy in 2001 and 2002, and General Motors Corp. and Ford Motor Co. were cut to below investment grade in May 2005, said Kiesel. The extra yield investors demand to own high-yield, high- risk, or junk, bonds rather than risk-free Treasuries shot up 21 basis points on Feb. 27 to 279 basis points, its worst day since May 10, 2004, Merrill Lynch data show. A week earlier the spread came within 5 basis points of its all-time low of 244 basis points, or 2.44 percentage points, in 1997. It ended yesterday at 299 basis points. Junk bonds are rated below Baa3 by Moody's Investors Service and BBB- by S&P. Few markets were left unscathed. European corporate bonds, emerging-market debt, mortgage securities, credit derivatives and bonds backed by everything from car loans to credit cards fell. Yields on developing nations' bonds average 190 basis points more than Treasuries, up from 164 basis points less than two weeks ago, according to JPMorgan Chase & Co.'s EMBI Plus index. No More `Goldilocks' ``It didn't take much for the market to reprice,'' said Scott Kirby, a bond fund manager at Minneapolis-based RiverSource Investments LLC, which manages about $20 billion in commercial and home mortgages. ``People are getting quite worked up.'' Procter & Gamble Co., the largest U.S. consumer-products maker, postponed the euro portion of a $4 billion bond sale because of the disruption. Companies sold $14.8 billion of debt in the U.S. last week, down from $25.2 billion the prior week. ``Based on the unstable markets, we decided to withdraw,'' said Doug Shelton, a spokesman for the Cincinnati-based maker of Folgers coffee and Crest toothpaste. Firms from Boston-based Putnam Investments to Fifth Third Asset Management in Grand Rapids, Michigan, are paring corporate bonds or shifting into higher-rated securities that may provide insulation from a slumping economy. Bank of America Corp., the third-biggest manager of bond sales in the U.S., is telling clients to unload corporate bonds because of concern that ``housing-led weakness'' may spread. A month ago, the firm, citing what it called a ``Goldilocks'' economy, recommended buying company debt. `A Shot' ``This is clearly a little bit of a shot across the bow to credit investors,'' said Paul Scanlon, team leader for U.S. high- yield at Putnam in Boston. Putnam, which manages $65 billion in fixed-income assets, has been selling its lowest-rated junk bonds in the past month, hedging against losses by using credit derivatives, increasing its cash holdings and buying bank debt, Scanlon said. Investors are focused on so-called subprime mortgages, loans for houses that are made to people with poor or limited credit records. They made up about a fifth of all new mortgages in 2006, according to the Washington-based Mortgage Bankers Association, an industry trade group. About 2 percent of subprime mortgages made last year were more than 60 days late after five months, almost twice the rate for ones made in 2005, and the worst in at least seven years, according to a Feb. 22 report from Barclays Capital. Subprime `Spillover' ``The spillover from the subprime market is only going to continue,'' said Kiesel, who predicts the housing market's deterioration will prompt consumers to curb spending, the economy to slow and the Federal Reserve to cut interest rates. Kiesel's prediction may already be coming true. The share of mortgages on which payments were at least 30 days overdue rose to 2.11 percent last quarter, the highest since 2002, from 1.72 percent the previous three months, the Fed said Feb. 27. The data aren't adjusted for seasonal patterns. Pimco has been ``underweight'' investment-grade corporate bonds since at least October 2005, meaning it owns a smaller percentage of the debt than contained in its benchmark indexes. -Continued Next Page-
- Continued - Greenspan and China Investors have more to worry about than just mortgages. Alan Greenspan, who retired in January 2006 as chairman of the Fed, said a recession in the U.S. is possible, though not probable, this year, according to people attending a CLSA Japan Forum in Tokyo on March 1. In an interview yesterday at his office in downtown Washington, he said there's a ``one-third probability'' of a U.S. recession this year. The biggest plunge in Chinese shares in a decade sparked a selloff in stock markets last week amid speculation a government crackdown on investments financed with borrowed money may cool demand from the world's fastest-growing major economy. Chinese investors are important to the U.S. bond market because they bought a net $31.3 billion of U.S. corporate bonds in 2006, contributing to the record $489 billion of debt purchased by international investors in 2006, according to data from the Treasury Department. `Kind of Wacky' ``It's kind of wacky in a way that Chinese equity markets are down and then it flows into high yield,'' said Margaret Patel, who manages $4.8 billion of junk bonds at Boston-based Pioneer Investment Management Inc. ``It shows how interconnected global markets are.'' Patel said she is buying higher-quality junk bonds issued by companies she already owns. In May 2005 high yield bonds tumbled when S&P downgraded Detroit-based GM and Ford of Dearborn, Michigan, the two-biggest U.S. automakers, to junk. High-yield bond spreads widened 180 basis points to 457 basis points during the two months after GM on March 15 cut its profit forecast, prompting speculation its ratings would be slashed. After Sept. 11, 2001, risk premiums on junk bonds ballooned to a record 1,025 basis points on Sept. 28, 2001, losing 6.9 percent that month. The debt rallied the next two months, until Enron's bankruptcy in December caused more losses. `Hungry Buyers' Pioneer Investment is using the slump as a buying opportunity, said Patel. ``You still have a lot of hungry buyers,'' said Patel. ``We're just seeing that little slush of nervousness. It reflects a change in sentiment, not a change in fundamentals. As long as defaults are so low it's hard to see where we can have a large correction at this point.'' The global default rate on speculative-grade bonds ended last year at a 10-year-low of 1.7 percent, defying projections in December 2005 and March 2006 that it would top 3 percent by now, according to Moody's. The default rate has fallen for the past five years, Moody's said. The selloff is ``something that's been somewhat overdue as we've had a one-way rally since August and investors have become very complacent,'' said Gregory Peters, head of U.S. credit strategy at New York-based Morgan Stanley, the fourth-biggest underwriter of corporate bonds. Peters recommends investors position themselves ``defensively'' as he predicts yield spreads will continue to fluctuate during the next month. LBO Risk For corporate bonds, ``the upside is you get to make 80 basis points of spread and the bad news is there ain't nothing too big to LBO right now,'' said Mitchell Stapley, who manages $13 billion as chief fixed-income officer at Fifth Third, referring to leveraged buyouts. Fifth Third has been underweight investment-grade corporate bonds for a year in part because of LBO risk, which he said ``hasn't been particularly paying off'' until now. The perceived risk of owning U.S. corporate bonds soared last week. Credit-default swap contracts based on $10 million in bonds in the Dow Jones CDX North America Crossover Index surged $32,750 to $143,000, according to Deutsche Bank AG in New York. It increased again yesterday, rising to $159,000, the highest in three months. The index on Feb. 22 fell to $107,500, its lowest since being created in 2004. Credit-default swaps are based on corporate bonds and loans and used to speculate on a company's ability to repay debt. An increase indicates traders see a higher risk of default. RiverSource is buying bonds with high credit ratings, such as AAA by S&P, because lower-rated bonds don't have returns yet that justify the risks that include the slowing housing market, according to Kirby. Dwight Asset Management Co., which oversees $4.5 billion in asset-backed securities, has avoided lower-rated bonds as well, according to analyst Janet Braggs. Asset-backed securities are bonds whose interest is derived from home, car, student or credit-card loan payments. ``The market began the year priced for perfection,'' Braggs said in an interview. ``I would not recommend that any investor get into this market because it seems poised to drop precipitously given any kind of bad news.''