Many of the participants in the short-term credit market use it as a place to deploy cash while waiting for higher risk opportunities. For example, hedge funds often purchase bonds nearing the end of their life as a way to earn income on their cash to avoid fee erosion. Likewise, family offices frequently deploy available cash in the short-term bonds of companies they know through their core businesses while awaiting higher ROIs elsewhere.
Because they are holding these bonds as cash substitutes, they will sell them as soon as the markets present higher expected returns, even if they must take a small loss on the transaction. (This has happened frequently in the past few months, as yields have been rising across the maturity spectrum.) For these investors, selling a bond at a 0.25% discount is a small price to pay in order to access the opportunities on the other side of the trade, but that 0.25% on a bond which is expected to be repaid within 3 months can result in a 1% increase or more in the yield. This creates materially higher yielding opportunities for buyers of those bonds, and today’s market is among the most attractive in years. This is not just because yields are higher, however; it is because those higher yields come with largely unchanged fundamental metrics. Which means, the savvy fundamental investor can get paid more for the same credit risk. Put another way, fair value has not changed; the bonds have just gotten cheaper.
This dynamic can become even more exaggerated in certain circumstances. For example, when market participants expect a company to refinance imminently, those bonds often trade at the same yield as the refinancing expectations. However, refinancing events are subject to market conditions and do not always happen on schedule, so it is essential to invest in creditworthy bonds in case one ends up holding them to maturity. Often, with higher coupon bonds, this means investors can earn an even higher total return if a company chooses to wait a bit longer to repay their debt.
However, this is not a common approach in short duration high yield. Many investors see the short-term refinancing as the key driver of an investment thesis. For weaker issuers, if a company chooses not to pay down debt at the first available opportunity, it may be that the ability to refinance is called into question. In this case, that bond may be materially riskier than expected. However, even for stronger credits, the difference between a 3-month time to repayment and a 9-month time to repayment can undermine the thesis of some investors.