More ‘zombie’ firms to fail leaving bondholders in the lurch: Jamieson Coote Bonds

The Virgin Australia retail investors scenario could be repeated, with the corporate bonds rally set to end, says JCB.

One of the nation’s top bond fund managers has warned of more troubles ahead for the volatile corporate bond market.

One of the nation’s top bond fund managers has warned of more troubles ahead for the volatile corporate bond market when government support ends in the coming months for so-called “zombie firms” that are unable to pay their debts.

Jamieson Coote Bonds, which is chaired by former Future Fund chief executive Mark Burgess and backed by Radek Sali’s Light Warrior investment group, invests only in high grade sovereign bonds and last year warned about the risks associated with the growing number of corporate debt offerings.

Those became apparent for retail investors following the collapse of Virgin Australia, which late last year issued $325m of high yield corporate bonds. The airline’s bondholders, including retail investors that participated in that issue, now face the prospect of heavy losses on their investment and are mounting a rival recapitalisation proposal for the airline.

The Virgin bonds were similar to the debt securities held by a number of high yield Listed Investment Trusts that have come to market in recent years.

“This rallying in all credit is something investors have to think through,’’ JCB chief investment officer Charlie Jamieson said on Wednesday of the surprise rally since April in the values of corporate debt securities in line with the sharemarket recovery.

“It doesn’t have enough velocity to pay its bills as they fall due.”

JCB executive director Angus Coote went further on the issue in the briefing to JCB’s investors, highlighting the dangers of government support packages for the normal operation of the economy, which usually saw highly leveraged businesses fail during times of stress and restored pricing normality in industries.

He pointed to what he called “the amount of zombie firms that are across the US economy- firms where debt servicing costs are not covered by their profits”.

“You are seeing companies survive when in previous cycles they went out of business,’’ he said.

Despite the rapid recovery on global sharemarkets, yields on 10-year US Treasuries have not rebounded, reflecting the pessimism in the bond market about the economic outlook.

The IMF has slashed its global growth forecast to minus 4.9 per cent for this year, from 3 per cent in April.

“We are still in essentially disaster relief funding mode. We are really in the eye of the storm,’’ Mr Jamieson said.

“We are still at the start of this and these crises can last for years. There is still an amount of water to go under the bridge here.”

Pricing in reality

Mr Coote added that the bond market was “very much pricing in the reality of what is happening with COVID-19”.

“The equities market is trying to keep excuses for keeping the V-shaped recovery going.

At some point we will see a snap back from that. It is very risky at the point we are at the moment for equity markets,’’ he said, noting JCB was looking at a “W, L or a U-shaped” recovery.

To fund the federal budget deficit flowing from the COVID crisis the Australian government is expected to continue issuing bonds. This week it sold $17bn of a new 2025 bond line, the second-largest sale on record, drawing bids worth $50.6bn.

“You need to offer a concession to get that size away and the bonds tend to perform thereafter,’’ Mr Jamieson said, noting JCB was a big participant in this week’s issue.

“These are good opportunities for us to generate additional alpha,’’ he said.

For the 12 months ending June, the group’s flagship CC JCB Global Bond Fund generated hedged returns of 5.48 per cent, slightly below its benchmark. The fund has returned 7.5 per cent annually since inception 15 months ago.