High-yield bond guru Marty Fridson still thinks his sector is overpriced.

The rigorous researcher of junk bonds said as much to a cohort of high-yield research analysts from hedge funds, banks, and asset managers during the New York Society of Security Analysts’ 23 rd  Annual High Yield Bond Conference.

The gathering followed a selloff in the asset class that has prompted concerns about whether high yield bonds are still worth the investment. As Treasury yields fell during April, junk bond yields did as well. After reaching a record low 4.95% on May 9, the Barclays U.S. High Yield Index sold off over 100 basis points  to reach 6.30% on June 11.

But the sector still isn’t all that attractive from a fair-value perspective, said Fridson, chief executive officer of FridsonVision LLC. He explained what he calls his Fair Value Model, which uses a regression to determine fair value in the market based on default rates, macroeconomic variables, credit availability, and the 5-year Treasury yield.

On May 31, he calculated the fair value at a 558 basis-point spread to Treasurys, while the spread of the Bank of America Merrill Lynch index was 462 basis points. That means the market is overvalued by 96 basis points.

“Even with the selloff, the market hasn’t come down to earth,” Fridson said.

Junk bond investors often track option-adjusted spreads to Treasurys, which indicate the premium over risk-less government debt that high-yield issuers pay their bondholders. Those spreads are currently at the low end of average historical levels. But the spread isnt necessarily the best way to determine how well bondholders are being compensated because risk is rarely, if ever, at average levels, Fridson said. Instead, investors should look at fair value measurements to determine whether bondholders are being adequately paid.

“There’s okay value. The market isn’t wildly overvalued or undervalued” after the backup in rates, said Alex Kirk, partner at River Birch Capital, on a panel about the buy-side outlook.

As speculation continues over potential Federal Reserve action to wind down its bond purchase program, volatility in the high-yield market is poised to continue. Buyers of high yield bonds shouldn’t be worried about putting their money into the asset class, but they should shorten their duration in anticipation of an uncertain market, panelists said.

But investors will have to get used to lower returns, said Andrew Feltus, portfolio manager at Pioneer Investment Management. The risk of falling bond values due to interest rate increases – known as duration risk – surpasses the risk of bond defaults, which is why it’s best to keep duration short, he said.

“We’re much more concerned about duration risk than credit risk,” said Feltus.

– Ben Eisen

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