One reason why style drift is an issue in public bond markets is that it is becoming harder to generate the 5% to 7% return institutional investors typically target from their fixed-income portfolios. As a result, demand is growing for riskier issuance, with average yields for CCC bonds dropping to just 5.66% in early May, a record for the junkiest of junk paper.
For example, just three months after emerging from Chapter 11 bankruptcy protection in early January, Chuck E. Cheese owner CEC Entertainment Inc. issued U.S. $650 million of bonds that Moody's rated Caa1, its riskiest tier. Yet demand was so strong that the company borrowed more and cut the interest payment to 6.75%.
According to S&P, the global corporate annual default rate in 2020 for issuers rated CCC, CC, and C was almost 50%, compared with about 1% for BB companies, which begs the question: Are investors being adequately compensated for all this extra risk they are taking?
Against this backdrop, it isn't surprising that allocators are becoming more jittery at the thought of portfolio managers reaching out to the furthest extremes of the credit spectrum to find the yield they need to meet long-term obligations.