Junk-Bond Veteran Says 30 Years of Stable Markets Are a Sham

(Bloomberg) -- The high-yield market hasn't owned up to the magnitude of price swings for the past 30 years -- reported declines during downturns are too few and far between for an asset class where value is often guesswork more than consensus.

That's the striking claim from Marty Fridson, a renowned market veteran with over three decades experience. In a sweeping study drawing on data from 1987 onwards, he concludes that U.S. junk prices have defied reality unlike their high-grade counterparts.

While data for the latter fall into an “almost perfect” distribution along a bell-shaped curve, junk notes resist normal trading patterns, the chief investment officer at Lehmann Livian Fridson Advisors finds.

That's allowed them to outperform when volatility rumbles through other risk assets, at least based on quoted data. Conversely, premiums may have been overstated during subsequent upturns.

“Reported prices understate the high-yield market's true volatility,” Fridson wrote in a note distributed by S&P Global Market Intelligence, on Wednesday. “Other market participants may find it unpalatable and propose other possible explanations.”

Fridson, who worked on some of the first trading models used in 1984 as head of corporate bond research at Morgan Stanley, analyzed the distribution of prices since 1987 to show too little variance relative to other assets.

High-yield debt trades mostly in over-the-counter transactions that are more opaque and less liquid than stocks.

Fridson isn't accusing anyone of fixing prices -- he says bouts of over-generous valuations may come down to the fact that with few or no actual trades to use as a yardstick, they're often wishful thinking.

“Basic financial theory says you should have a bell-shaped curve,” Fridson said in an interview. “The problem could be that issues that don't trade get marked on mark-to-market valuations. A trader's best guess might not reflect the true extent of the price decline. You'd have to have a lot of people involved for it to be a conspiracy.”

To contact the reporter on this story: Cecile Gutscher in London at cgutscher@bloomberg.net.

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Sid Verma, Dave Liedtka

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