Senior Fund Manager and Head of Credit at J O Hambro Capital Management Lale Topcuoglu joins Yahoo Finance’s On The Move to weigh in on how the credit and equity markets are faring amid the coronavirus crisis.

Video Transcript

- I want to turn our attention to more coming out of Washington in the form of-- Larry Kudlow has actually suggested that the administration is looking at, perhaps, issuing some kind of coronavirus bonds. That brings up the issue of fixed income. And I want to invite into this discussion Lale Topcuoglu. Who is the senior fund manager and head of credit at J.O. Hambro Capital Management. Good to have you here.

Before we address what the administration may do with new bonds being issued, good, old fashioned investment grade corporate bonds, as you say, remain one of the casualties of this downturn. Yet, we had a guest on last week who was telling us that they're starting to issue even some of the higher yielding or perhaps more risky corporate debt. Are you seeing that actually happen?

LALE TOPCUOGLU: Yes, the high yield market has opened up. And there is, you know, active issuance. It's certainly not as active as the investment grade market. Because remember, investment grade market-- actually, the biggest issuance is coming and being done by companies that are effectively shut out of the commercial paper market, right. So they are basically replacing their commercial paper commitments in the primary market, in the actual bond market. And you know, high yield guys, they never have access to the commercial paper anyway.

And so there is a few select issuance. But it's certainly not as remotely close to the numbers we're seeing on the investment grade side.

- And Lale, what are we seeing just overall? Give us sort of the bird's eye view of what we're seeing in credit right now. Because a few weeks ago, we were hearing from investors that the credit markets were pricing in even a worst case scenario compared with the equity market. Now that equities have started to recover, what are we seeing happen in credit? And what scenario is it now pricing at?

LALE TOPCUOGLU: You know, the credit market actually hasn't really followed the equity markets in this last two days of rally we've seen. Investment grade market-- look, there was a lot of issuance. It needs to get digested. So that market will take its cues from the new issuance. And then you've got to wait for the earnings.

The high yield market has two issues. One is the downgrade pressure that's coming in as investment grade companies get downgraded to high yield. If you run with the assumption that it's going to be somewhere around $250 billion this year on a $1.2 trillion dollar US high yield market, that's going to cause some indigestion.

But also take a step back, look at the high yield market. A third of the high yield market, the issuer base, is at the epicenter of it. It's the energies. It's the REITs. It's the lodging. It's the leisure. So until you know how the depth and the duration of this fall-off we're going to go through, it is very hard to make assumptions around what the capital structure looks like.

BRIAN CHEUNG: Hey, it's Brian Cheung here. So to bring the Federal Reserve into all this, seems like they've been trying to backstop the investment grade market with their primary credit and secondary credit facilities. But they've also been trying to target things through their commercial paper facility. A lot of that has been targeted at investment grade. That's very explicit from what the Fed has said.

I'm wondering, first of all, what has been the success of those backstops so far in market liquidity? And secondly, do you think the Fed's going to have to step in at some point on junk rated bonds?

LALE TOPCUOGLU: Oh, I'm so glad you asked this. Because there are two things that I will say. The first one, I actually disagree that they're backstopping the investment grade market. What they did is they backstopped the commercial paper market. And what they-- and the reason why they actually backstopped the commercial paper market is because the prime money market funds which invest in repo, treasuries, and commercial paper-- they lost 25% of their assets in six business days.

So you can't have a run on a money market fund. Once you have that run, it's game over. Let's pack it up and go home.

So they backstopped that. And as a consequence of that, they ended up backstopping the CP market. Now, who are the large issuers in CP? They're the single-A rated corporates. And as a result, the corporate market got a little bit of a halo effect out of that.

Now, if you read their disclosures, they're not even actively saying they're going to go on by ETFs. It's just right there as a footnote. It is a contingency plan. But given the way the LQD, which is the index, has rallied-- you know, I think they've already done without even doing anything. Because remember, the commercial paper facility is not even effective yet. We're still a couple days, you know, far away from the implementation. They've already achieved what they're going to do.

Should they buy high yield? Absolutely not. The reason for that is companies become high yield because they want to juice their shareholder returns. It is not the only area of the capital structure you can issue. You can always raise equity, if you're public. They choose not to. You can issue convert, which will create dilution down the road. They choose not to.

They issue high yield because credit was dirt cheap. And it was the way to lower your [? WACC, ?] so you can get a higher return in the end. You know, once you go down that route, the moral hazard exponentially rises.

- But what's--

LALE TOPCUOGLU: And I would also say-- go ahead.

- Let me ask you. That's part of what you're saying here, then what happens to, as you told us, the almost $1 trillion of the-- you know, the corporate bond market that's at risk of being downgraded from triple-B?

LALE TOPCUOGLU: It's-- you know, the corporate-- there will be triple-B's that will get downgraded, right. But again, there is-- there are industries that will feel the pressure of that. And it's a consequence of, you know, managements, perhaps, being a little bit laid back about their capital structure.

They didn't have to do the dividends. They didn't have to do the share buybacks. So you know, these are the choices that management teams do. And as a result, it comes to haunt them, because you may be caught on the wrong side.

So I do think there is going to be around $250 billion that will get downgraded to high yield. And once you get downgraded to high yield, it actually takes you a whole lot longer time to come back up. And they're just going to have to manage their capital structure appropriately. It's-- you know, it's just the way.

And on the high yield side, there's a reason why it's called a junk market. You know, welcome to my world. It's, you know-- I think people got too cute about the lack of income and yield. You know, 4% earning double-B's sounded good when everything else was yielding 1.

- All right. Lale Topcuoglu, senior fund manager and head of credit, J.O. Hambro. Thank you very much for being here, talking to us about what's going on in fixed income. We appreciate it.