(Bloomberg) — A previously gloomy corner of the debt world has become the biggest winning trade in global financial markets, with returns few traders have seen in more than a decade.
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Hybrid bonds, the riskiest part of a real estate company’s debt, have returned more than 75% this year. For the 10 best-performing securities known as subordinated bonds, returns for the period are about 170%, beating shares of Nvidia Corp., the darling of the AI craze, by 20 percentage points.
It’s the kind of rapid turnaround few could have predicted as landlords around the world creaked under the weight of higher interest rates and changing work habits in the wake of the Covid-19 pandemic. Now real estate debt is becoming an early winner as major central banks cut borrowing costs while prioritizing the economy over fighting inflation.
“I can’t remember anything like it in my career,” says Andrea Seminara, CEO of London-based Redhedge Asset Management, who started working in the financial sector at the height of the global financial crisis in 2008. “The magnitude of the profits is unprecedented. , unless we are looking at purely emergency situations.”
Replacement costs
Landlord subordinated bonds had fallen by almost 50% after central banks started raising rates in 2022. Higher financing costs caused the cost to replace them to skyrocket, leaving investors concerned 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 penalized due to technical factors,” said Andreas Meyer, founder of Hamburg-based Fountain Square Asset Management. “There was blood on the street.”
For Seminara, buying at these low levels was essentially a gamble that companies would be able to pay off their debts and that falling inflation would allow central banks to cut interest rates. Both turned out to be 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 key rates and leaving open the possibility of further large cuts.
Meyer’s event-driven fund is one of the funds that has reaped the benefits, gaining as much as 80% in its hybrid bonds. He still has exposure in the sector.
The biggest risk now is that there is little juice left in the market. Strategists Barnaby Martin and Ioannis Angelakis of Bank of America Corp. pointed out in a report last week that “real estate loan valuations have clearly moved closer to their peak.”
Yet buyers and sellers are becoming increasingly confident that the commercial real estate market is bottoming out. Many are looking to put capital to work as the interest rate pain begins to subside.
“We’ve been through a sh*tstorm. No one has seen as aggressive monetary policy as we have seen over the last two years,” Ron Dickerman, founder of Madison International Realty, said in an interview. “A few interest rate cuts will not create a market, but there is optimism.”
Weekly overview
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China has unveiled a series of stimulus measures aimed at boosting weak growth in the country. It unveiled its biggest package yet to shore up the troubled real estate market, cutting financing costs on as much as $5.3 trillion in mortgages and lowering down payment requirements for purchasing a second home to an all-time low.
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China is also considering injecting up to 1 trillion yuan ($142 billion) of capital into its largest state-owned banks to boost their capacity to support the struggling economy.
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While some details are missing, the unusual pace and intensity of the stimulus announcements indicated a sense of urgency in Beijing to put growth on track towards the target of around 5%, boosting market sentiment.
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In addition, the country started to market its first euro-denominated bond in three years.
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US companies and Asian issuers stormed the debt markets following the Federal Reserve’s decision last week to cut interest rates by half a percentage point.
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A resurgence in mergers and acquisitions dealmaking is pushing the US high-quality bond market to its highest issuance pace since 2020, putting it on track to reach $1.5 trillion in sales.
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Banks and other lenders have lined up more than €10 billion in debt to support a takeover of Sanofi SA’s consumer health division, as one of the year’s most hotly anticipated sales reaches its final stages.
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Blue Owl Capital Inc. led the $3.2 billion private debt financing to support the acquisition by Blackstone Inc. and Vista Equity Partners of software company Smartsheet Inc., with 20 other lenders participating.
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Citigroup Inc. and Apollo Global Management Inc. are partnering in the fast-growing private lending market, agreeing to work together on deals worth $25 billion over the next five years.
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Atlas SP Partners, the structured credit business of Apollo Global Management Inc., has received its broker-dealer license and is preparing to begin secondary trading.
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Country Garden Holdings Co. has won approval from bondholders to defer payments on its nine-yuan bonds by six months, giving the developer more time to map out a domestic debt overhaul.
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Credit Agricole SA is looking to raise capital with a 10-year bond, adding to a recent crop of longer-dated instruments as investors look to take advantage of the Federal Reserve’s interest rate cuts.
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Altice France has held talks with funds including Apollo Global Management about raising new debt to repay looming maturities, a move that could potentially hurt existing creditors.
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A group of banks led by Bank of America Corp. has tightened terms on a leveraged loan offering to help finance Platinum Equity’s acquisition of GSM Outdoors, as the deal struggled to attract investor demand.
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Dish Network Corp. is close to closing a deal with some of its convertible bond holders that will provide the company with new financing and allow it to extend the term of its debt.
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Hooters of America, along with lenders and advisors, is amid revenue declines that are prompting the restaurant chain to close several locations.
In motion
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Brian Sauvigne, a former senior managing director of Blackstone Inc., rejoined Bank of Montreal’s financial sponsorship group.
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RBC Capital Markets has hired Sam Pfeiffer, formerly at Morgan Stanley, as head of US investment grade systematic credit trading.
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M&G Investments has appointed Joe Sullivan-Bissett as investment director for its £137 billion fixed income division, reporting to David Parsons, head of its fixed income specialist team.
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Alberta Investment Management Corp. appointed David Scudellari, the fund’s head of international investments, 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 leaving.
–With help from Eleanor Duncan and Dan Wilchins.
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