the distressed debt market and a possible new etf on ...€¦ · the distressed debt market and a...
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The Distressed Debt Market
and a Possible New ETF on
Defaulted and Distressed
Bonds
Dr. Edward Altman
NYU Stern School of Business
Investing in Distressed Securities
GARP Chapter Meeting
New York
May 22, 2014
Distressed Bonds: Corporate Bonds with a
Option Adjusted Spread (OAS) ≥ 1,000bp
Distress Ratio: Percent of High-Yield Bonds
with a OAS ≥ 1,000bp
2
Distress Ratio History
2000 – 2014 (4/30)
Date Distress Ratio
Annual Default Rate
(t+1)
Default Rate(t+1)
/Distress Ratio(t) (%)
12/31/2000 37.33 9.80 26.25
12/31/2001 24.36 12.79 52.52
12/31/2002 31.21 4.66 14.93
12/31/2003 8.40 1.25 14.86
12/31/2004 4.96 3.37 68.05
12/31/2005 5.47 0.76 13.92
12/31/2006 1.62 0.51 31.44
12/31/2007 10.35 4.65 44.97
12/31/2008 81.29 10.74 13.22
12/31/2009 14.53 1.13 7.78
12/31/2010 7.19 1.33 18.43
12/31/2011 17.88 1.62 9.06
12/31/2012 9.88 1.04 10.57
12/31/2013 5.29 n/a n/a
4/30/2014 5.03 n/a n/a
Average 18.55 4.13 22.25
Median 10.11 1.62 14.93
Sources: Bank of America Merrill Lynch & NYU Salomon Center
3
Distress Ratio History
2000 – 2014 (4/30)
Source: Bank of America Merrill Lynch4
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Distress Ratio Median Distress Ratio
Estimated Size of the Distressed Bond
Market Based on Distress Ratio
102
5516 5 18 21 9 10
64 73
223
158
236
6946 59
16
111
887
168
88
242
120
74 69
-
150
300
450
600
750
900
1,050
1,200
1,350
1,500
1,650 1
99
0
19
91
19
92
19
93
19
94
19
95
19
96
19
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00
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14
(1
Q)
$ B
illi
on
s
HY Bond Mkt Distressed Bond Mkt
Sources: Distress Ratio used in calculations from BofAML. HY Bond Market size from NYU Salomon Center estimates.
5
Distribution of High-Yield Bond Issues by OAS
Over Comparable Duration Treasury Bonds,
March 31, 2013
Source: Bank of America Merrill Lynch. Data based on the population of distressed credits including only U.S. domiciled companies.6
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
0
200
400
600
800
1000
1200
1400
1600
1800
< 500 500-749 750-999 1000-1249 1250-1499 1500-1749 1750-1999 ≥ 2000
Pe
rce
nt
of
Tota
l
No
. of
Issu
es
Spread (bp)
No. of Issues Percent of Total
8
Estimated Face And Market Values Of
Defaulted And Distressed Debt ($ Billions)
2012 – 2014 (1Q)
1 Calculated using: (2013 defaulted population) + (2014 Defaults) - (2014 Emergences) - (2014 Distressed Exchanges). 2 Based on 4.80% of the high-yield bond market ($1.467 trillion) as of 31 M ar. 14. 3 Based on a private/public ratio of 2.0.
Source: NYU Salomon Center and estimates by Professor Edward I. Altman.
Market Value
12/31/2012 12/31/2013 3/31/2014 12/31/2012 12/31/2013 3/31/2014
Market/Face
Ratio
Public Debt
Defaulted 252.39 247.90 246.83 (1)
100.96 111.55 86.39 0.35
Distressed 130.06 76.06 70.36 (2)
91.04 53.24 45.73 0.65
Total Public 382.45 323.96 317.19 191.99 164.79 132.13
Private Debt
Defaulted 504.78 495.79 493.66 (3)
277.63 347.06 320.88 0.65
Distressed 260.11 152.12 140.72 (3)
208.09 121.69 105.54 0.75
Total Private 764.89 647.91 634.39 485.72 468.75 426.42
Total Public and Private 1,147.34 971.87 951.58 677.71 633.54 558.55
Face Value
9
Size Of The US Defaulted And Distressed Debt
Market ($ Billions)
1990 – 2014 (1Q)
Source: Author’s Compilations
$-
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000 Face Value Market Value
10
Updated Market-Based Annual Default Rate Forecast
Annual Default Rate (t+1) versus Distressed Ratio (t)
Application
Distress ratio (12/30/2011) of 17.88%, forecast PD for 2012 = 3.93% vs. actual of 1.62%
Distress ratio (12/31/2012) of 9.88%, forecast PD for 12/31/2013 = 2.65% vs. actual of 1.04%
Distress ratio (12/31/2013) of 5.29%, forecast PD for 12/31/2014 = 1.61%
Distress ratio (04/30/2014) of 5.03%, forecast PD for 04/30/2015 = 1.57%
The regression equation is
Default Rate = 0.86 + 0.14 * Distress Ratio
Predictor Coef SE Coef T P
Constant 0.8634 0.4504 1.9170 0.0696
Spread 0.1412 0.0175 8.0626 0.0000
S = 1.5731 R-Sq = 76.5% R-Sq(adj) = 75.3%
Sources: Slide 6, Bank of America Securities and authors’ compilations
0
2
4
6
8
10
12
14
0 20 40 60 80
De
fau
lt R
ate
(t+
1)
%
Distress Ratio (t) %
Annual Default Rates (t+1) vs. Distress Ratios (t) (1990-2012)
y = 0.1412x + 0.8638 R2 = 0.7647
Hedge Fund Distressed Debt Index Returns
2003 – 2014 (4/30)
Calendar Year
Dow Jones/
Credit Suisse Hennessee HFR GAI
Altman-Kuehne
Combined
2003 25.12% 26.79% 29.58% 27.42% 49.30%
2004 15.60% 18.98% 18.89% 18.19% 15.14%
2005 11.75% 9.71% 8.25% 9.34% 1.73%
2006 15.58% 15.78% 15.95% 15.33% 23.38%
2007 8.28% 8.31% 5.07% 7.37% -3.30%
2008 -20.48% -29.28% -25.21% -21.05% -47.52%
2009 20.95% 42.97% 28.54% 24.69% 55.99%
2010 10.26% 15.47% 12.12% 16.35% 17.70%
2011 -4.24% -2.36% -2.42% -1.9% -3.02%
2012 11.77% 13.61% 10.40% 13.8% 7.63%
2013 16.00% 16.16% 14.04% 18.4% 19.37%
2014 (4/30) 3.45% n/a 3.06% 4.0% 5.10%
ΔLM (Apr) * 0.37% n/a 0.26% 0.6% -0.83%
2003-13 Arithmetic Average
(Annual) Rate10.05% 12.38% 10.47% 11.63% 12.40%
Standard Deviation 12.60% 17.89% 15.10% 13.51% 27.71%
2003-13 Compounded
Average (Annual) Rate9.31% 10.91% 9.41% 10.79% 8.71%
*Last Month Change. Sources: Bloomberg & NYU Salomon Center
11
Forthcoming ETF on Defaulted and
Distressed Bonds
12
Market Vectors Index Solutions
Launches Altman
North America Defaulted And
Distressed Bond Index
(MVRCOV) (May 21, 2014)
Comparison of Returns
Annual Total Return (%)
Year
BofA ML
Distressed Index
Altman-Kuehne
Defaulted Bond
Index
Altman-Kuehne
Defaulted Combined
Index
Citi High-Yield Bond
Index S&P 500 Index
2004 24.78 18.93 15.14 10.79 10.88
2005 -15.95 -1.78 1.73 2.08 4.92
2006 42.80 35.62 23.38 11.85 15.80
2007 -12.07 -11.53 -3.30 1.83 5.50
2008 -44.91 -55.09 -47.52 -25.91 -37.00
2009 116.67 96.42 55.99 55.19 26.46
2010 25.41 25.76 17.70 14.32 15.06
2011 -6.61 -3.66 -0.41 5.52 2.11
2012 24.10 2.63 7.63 15.17 15.99
2013 11.66 29.25 19.37 7.22 32.39
2014 (4/30) 2.25 5.18 5.10 3.63 2.56
2014 (1Q) 2.60 7.93 5.98 2.98 1.81
2004-2013 (10 year)
Arithmetic Avg Return
Geometric Avg Return
16.59
9.82
13.65
7.11
8.97
5.59
9.81
8.23
9.21
7.40
2009-2013 (5 year)
Arithmetic Avg Return
Geometric Avg Return
34.25
28.59
30.08
25.85
20.05
18.62
19.48
18.25
18.40
17.94
2011-2013 (3 year)
Arithmetic Avg Return
Geometric Avg Return
9.72
8.98
9.41
8.52
8.86
8.56
9.30
9.22
16.83
16.18
Sharpe Ratio (10 year) 0.266 0.222 0.153 0.243 0.22413
Comparison of Returns:
Combined Distressed & Defaulted Index with H.Y. Bonds & S&P 500
Annual Total Return (%)
Year
Combined Distressed &
Defaulted Index , 50% Split Citi High-Yield Bond Index S&P 500 Index
2004 21.86 10.79 10.88
2005 -8.87 2.08 4.92
2006 39.21 11.85 15.80
2007 -11.80 1.83 5.50
2008 -50.00 -25.91 -37.00
2009 106.55 55.19 26.46
2010 25.59 14.32 15.06
2011 -5.14 5.52 2.11
2012 13.37 15.17 15.99
2013 20.46 7.22 32.39
2014 (4/30) 3.72 3.63 2.56
2014 (1Q) 5.27 2.98 1.81
2004-2013 (10 year)
Arithmetic Avg Return
Geometric Avg Return
15.12
8.64
9.81
8.23
9.21
7.40
2009-2013 (5 year)
Arithmetic Avg Return
Geometric Avg Return
32.16
27.43
19.48
18.25
18.40
17.94
2011-2013 (3 year)
Arithmetic Avg Return
Geometric Avg Return
9.56
9.01
9.30
9.22
16.83
16.18
Sharpe Ratio (10 year) 0.248 0.243 0.224 14
Annualized Return Distribution (ARD)
Analysis – Original OAS Volatility
Average Annualized Return (Jul -1997 to Dec-2012)
Annualized PerformanceRelative to LO VOL Portfolio
HI VOL portfolio -1.30% -12.22%
LO VOL portfolio 10.92% --
High-Yield Index 6.98% -3.94%
Distressed Index 4.54% -6.38%
S&P 500 TR Index 2.84% -8.08%
Barclays U.S. Aggregate Index
5.94% -4.98%
Source: E.I. Altman, J.F. Gonzales-Heres, P. Chen & S. Shin, “The Return/Volatility Trade-Off of Distressed Corporate Debt Portfolios”, The
Journal of Portfolio Management, Winter 2014, pp 69-85.
16
Annualized Return Distribution (ARD)
Analysis – Normalized OAS Volatility
Average Annualized Return (Jul -1997 to Dec-2012)
Annualized PerformanceRelative to LO VOL Portfolio
HI VOL portfolio 3.46% -11.09%
LO VOL portfolio 14.55% --
High-Yield Index 6.98% -7.57%
Distressed Index 4.54% -10.02%
S&P 500 TR Index 2.84% -11.71%
Barclays U.S. Aggregate Index
5.94% -8.61%
Source: E.I. Altman, J.F. Gonzales-Heres, P. Chen & S. Shin, “The Return/Volatility Trade-Off of Distressed Corporate Debt Portfolios”, The
Journal of Portfolio Management, Winter 2014, pp 69-85.
17
Cumulative Default Rate since First Entering
a State of Distress – Original OAS Volatility
Source: E.I. Altman, J.F. Gonzales-Heres, P. Chen & S. Shin, “The Return/Volatility Trade-Off of Distressed Corporate Debt Portfolios”, The
Journal of Portfolio Management, Winter 2014, pp 69-85. 18
Source: E.I. Altman, J.F. Gonzales-Heres, P. Chen & S. Shin, “The Return/Volatility Trade-Off of Distressed Corporate Debt Portfolios”, The
Journal of Portfolio Management, Winter 2014, pp 69-85.
Cumulative Default Rate since First Entering a
State of Distress – Normalized OAS Volatility
19