(Bloomberg) — A previously gloomy corner of the debt world has become the biggest winning trade in global financial markets, producing returns that few traders have seen in more than a decade.
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Hybrids, the riskiest slice of a real estate company’s debt, have returned more than 75% this year. For the top 10 performers for the securities also known as subordinated bonds, returns amount to about 170% in the period, beating Nvidia Corp.’s stock, the darling of the AI craze, by 20 percentage points.
It’s the kind of swift turnaround that few could have predicted when landlords around the world were creaking under the weight of higher interest rates and changing work habits following the Covid-19 pandemic. Now, real estate debt is becoming an early winner from major central banks cutting borrowing costs amid a pivot to prioritizing the economy over battling inflation.
“I cannot recall something similar in my career,” said Andrea Seminara, chief executive officer at London-based Redhedge Asset Management, who started working in finance at the height of the global financial crisis in 2008. “The magnitude of the gains is unprecedented, unless we look at pure distressed situations.”
Replacement Cost
Landlords’ subordinated bonds had plunged nearly 50% after central banks began to increase rates in 2022. Higher borrowing costs meant the cost to replace them shot up, leaving investors fearful that repayment would be delayed indefinitely.
Companies can also sometimes skip coupons on the notes without triggering a default, making them less popular with investors.
“These bonds were punished due to technical factors,” said Andreas Meyer, founder of Hamburg-based Fountain Square Asset Management. “There was blood on the streets.”
For Seminara, buying at those depressed levels was effectively a bet that companies would be able to replace debt that was coming due and that falling inflation would allow central banks to cut interest rates. Both proved correct.
The companies faced a so-called maturity wall that collapsed in historic fashion this year as capital flowed into the credit market, allowing landlords to issue new debt to refinance old bonds. Meanwhile, the Federal Reserve this month joined the European Central Bank and the Bank of England in cutting its policy rate and leaving open the possibility of further large cuts.
Meyer’s event-driven fund is among those that reaped the benefits, gaining as much as 80% in its hybrid bonds. He still has exposure in the sector.
The main risk now is that there is little juice left in the trade. Strategists Barnaby Martin and Ioannis Angelakis at Bank of America Corp. flagged in a report last week that “valuations are clearly nearer to becoming full” in real estate credit.
Still, buyers and sellers are becoming more confident that the commercial real estate market is bottoming out. Many want to start putting capital to work as the interest rate pain starts to ease.
“We have lived through a sh*tstorm. No one has lived through a monetary policy as aggressive as we have seen in the last two years,” Madison International Realty founder Ron Dickerman said in an interview. “A couple of rate cuts does not make a market, but there’s optimism.”
Week in Review
China disclosed a series of stimulus measures designed to boost flagging growth in the nation. It unveiled its biggest package yet to shore up its beleaguered property market, lowering borrowing costs on as much as $5.3 trillion in mortgages and easing down-payment requirements for second home purchases to a historical low.
China is also considering injecting up to 1 trillion yuan ($142 billion) of capital into its biggest state banks to increase their capacity to support the struggling economy.
While some details are missing, the unusual pace and intensity of the stimulus announcements signaled a sense of urgency in Beijing to put growth on track for the around 5% target, buoying market sentiment.
Separately, the nation began marketing its first euro-denominated bond in three years.
US companies and Asian issuers stormed debt markets following the Federal Reserve’s decision last week to lower its benchmark interest rate by half-a-percentage-point.
A resurgence in mergers and acquisitions dealmaking is turbocharging the US high-grade bond market to its fastest pace of issuance since 2020, putting it on track to post $1.5 trillion of sales.
Banks and other lenders are lining up more than €10 billion ($11.1 billion) of debt to back a buyout of Sanofi SA’s consumer health division, as one of the most hotly-anticipated sales of the year reaches its final stages.
Blue Owl Capital Inc. led the $3.2 billion private debt financing supporting Blackstone Inc. and Vista Equity Partners’ buyout of software firm Smartsheet Inc., with 20 other lenders participating.
Citigroup Inc. and Apollo Global Management Inc. are teaming up in the fast-growing private credit market, agreeing to work together on $25 billion worth of deals over the next five years.
Apollo Global Management Inc.’s structured credit business Atlas SP Partners received its broker-dealer license and is preparing to start secondary trading.
Country Garden Holdings Co. has won bondholders’ approval to push back payments on its nine yuan bonds by six months, giving the developer more time to map out an onshore debt overhaul.
Credit Agricole SA is looking to raise capital with a bond that has to be repaid after only a decade, adding to a recent raft of longer-duration instruments as investors look to take advantage of the Federal Reserve’s rate cuts.
Altice France has held talks with funds including Apollo Global Management about raising new debt to repay looming maturities, a move that would potentially hurt existing creditors.
A group of banks led by Bank of America Corp. sweetened terms on a leveraged loan offering to help finance Platinum Equity’s acquisition of GSM Outdoors as the deal struggled to attract demand from investors.
Dish Network Corp. is close to striking a deal with some of its convertible bondholders that would give the company new financing and help it extend its debt maturities.
Hooters of America is huddling with lenders and advisers amid revenue declines that pushed the restaurant chain to shutter several of its locations.
On the Move
Brian Sauvigne, a former Blackstone Inc. senior managing director, rejoined Bank of Montreal’s financial-sponsors group.
RBC Capital Markets hired Sam Pfeiffer, previously with Morgan Stanley, as head of US investment grade systematic credit trading.
M&G Investments recruited Joe Sullivan-Bissett to be an investment director in its £137 billion fixed income division, reporting to David Parsons, head of the fixed income specialist team.
Alberta Investment Management Corp. appointed David Scudellari, the fund’s head of international investment, to oversee private assets and strategic partnerships, and Justin Lord as senior executive managing director for public markets. Meanwhile, Chief Investment Officer Marlene Puffer is departing.
–With assistance from Eleanor Duncan and Dan Wilchins.
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