Expert warns of high-yield energy debt

The market for high-yield mining and energy debt is suffering from some of the same issues that sparked the 2008 crisis as investors turn a blind eye to poor credit in their desperation for fatter returns, according to an executive with one of Canada’s largest hedge funds.

Fund managers are snapping up lower-quality debt in a bid to outperform their competitors and retail investors do not understand the underlying credit risk, particularly in exchange-traded funds, said Rick Rule, chief executive of Sprott US Holdings, a subsidiary of Toronto-based Sprott with €6.5bn under management.

“It wouldn’t take anything at all to have the same circumstance occur in mining and energy junk debt that happened in mortgage securities,” said Mr Rule.

“Remember that nothing precipitously changed in the housing market in 2008. It’s just that people began to do the arithmetic.”

Mr Rule sees a similar thirst for yield driving investors into junk debt that pushed investors into subprime mortgages, which ultimately blew up, helping to touch off the financial crisis.

High-yield bond spreads hit a 32-month low last week, according to the Bloomberg Barclays High Yield Index. Energy bonds have returned 51% over the past year, the best-performing industry, according to a Bank of America Merrill Lynch index.

Any kind of lack of faith in credit or another downturn in the price of oil and gas could trigger a 2008-type crisis, said Mr Rule.

A rise of 200 basis points in the US 10-year Treasury, currently at 2.5%, could also cause “cracks” in the high-yield market, he said.

The risks are exacerbated by exchange-traded funds as they have become bigger buyers of high-yield deals, including smaller issues of $150m (€141.5m) to $200m, said Mr Rule at the Prospectors & Developers Association of Canada convention, the world’s biggest mining gathering.

“The credit markets are the most generous I’ve seen them in my entire life,” he said.