Aug. 6 (Bloomberg) — The value of new junk bonds is rising bythe most in at least three years relative to outstanding debt aslow trading volume and faster cash inflows into mutual funds forceinvestors to jockey for initial offerings.

New speculative-grade issues have outperformed Barclays Plc'shigh-yield index by about 1.8 percent this year, more than in 2011and 2010. Notes from Smithfield, Virginia-based Smithfield FoodsInc., the largest U.S. pork processor, rose 5.8 cents to 105.3cents on the dollar since being sold July 18, according to Trace,the bond-price reporting system of the Financial IndustryRegulatory Authority.

Junk-bond fund managers that have received $43.1 billion ofdeposits this year are struggling to obtain securities as tradingvolumes decline, reducing the accessibility of older bonds. Thesqueeze is exacerbated by a 54 percent drop in monthly debt salessince May, data compiled by Bloomberg show.

It's “a food fight” for new issues, said Mark Vaselkiv,president of the $9.36 billion T. Rowe Price High Yield Fund. “Themajor dynamic that's affecting the market is a relative scarcity ofgood quality product. Many of the major high-yield managers arestruggling to stay fully invested.”

Beating Stocks

High-yield, high-risk bonds, graded below Baa3 by Moody'sInvestors Service and lower than BBB- at Standard & Poor's,have returned 9.45 percent this year, including reinvestedinterest, Bank of America Merrill Lynch indexes show, compared with8.82 percent for the Dow Jones Industrial Average when includingdividends.

Investors are looking further down the credit spectrum insearch of returns as the Federal Reserve holds benchmark interestrates near zero through at least late 2014 to help jump-start aneconomy in which the unemployment rate has held at 8 percent ormore for 42 months.

Junk-bond funds received $9.32 billion of inflows in July, themost since February, EPFR Global data show.

“Demand is intense” and the allocations of new bonds “arefinite,” Martin Fridson, a global credit strategist in New York atBNP Paribas Investment Partners, said in a telephone interview.“It's become tough to buy the acceptable quality paper that theportfolio managers want to own.”

Elsewhere in credit markets, the cost of protecting corporatedebt from default in the U.S. fell, with the Markit CDX NorthAmerica Investment Grade Index, which investors use to hedgeagainst losses or to speculate on creditworthiness, declining 1.2basis points to a mid-price of 102.3 basis points as of 11:14 a.m.in New York, according to prices compiled by Bloomberg.

Rate Swaps

That's the lowest level on an intra-day basis since May 10 forthe measure, which typically falls as investor confidence improvesand rises as it deteriorates. Credit-default swaps pay the buyerface value if a borrower fails to meet its obligations, less thevalue of the defaulted debt. A basis point equals $1,000 annuallyon a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of bondmarket stress, decreased 0.75 basis point to 20 basis points as of11:14 a.m. in New York. The gauge narrows when investors favorassets such as corporate bonds and widens when they seek theperceived safety of government securities.

Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, arethe most actively traded dollar-denominated corporate securities bydealers today, with 50 trades of $1 million or more as of 11:07a.m. in New York, Trace data show.

Smithfield Bonds

Recently issued speculative-grade securities have returned 1.8percent more than the Barclays U.S. High Yield Index this year,compared with 1.71 percent last year and 1.28 percent in 2010.About half of the outperformance came in the first day of trading,according to an Aug. 3 report by Barclays analysts led by JeffreyMeli and Bradley Rogoff.

“Managers like ourselves that don't get the allocations theywant will go back into the secondary market to fill out orders,” T.Rowe's Vaselkiv said in a telephone interview. “We typically end uppaying more than the offering price to fill out allocations.”

Smithfield sold $1 billion of 6.625 percent, 10-year notes onJuly 18 in the company's first debt sale in more than three years,increasing the size from $650 million, a person familiar with thetransaction said at the time of the deal who asked not to beidentified because the terms are private.

The bonds were sold at a spread of 515 basis points more thansimilar-maturity U.S. Treasuries, 101 basis points less than therelative yield on Smithfield's June 2009 sale of $850 million of 10percent securities due in July 2014.

Cash Inflows

Demand for larger returns has induced investors to seekout the debt of high-yield, high-risk companies such as New York-based CIT Group Inc., the small-businesslender that exited bankruptcy two years ago, pushing yields on thefirm's bonds lower than the average for all investment-gradedebt.

The company's $1.5 billion of 4.75 percent notes sold inFebruary traded at 104.2 cents on the dollar Aug. 3 for a yield of3.01 percent, Bloomberg prices show, compared with average yieldson all investment-grade debt of 3.08 percent based on Bank ofAmerica Merrill Lynch's U.S. Corporate Master index.

B/E Aerospace Inc. sold $500 million of 5.25 percent, 10- yearnotes on March 8, after increasing the offering from $375 million,the Wellington, Florida-based company said in a statement at thetime. The maker of premium seating used on Deutsche Lufthansa AG's747-8 airplanes sold $800 million more of the notes in a reopeningon July 12, up from the $675 million initially planned.

The notes, priced at par in the first sale, have climbed to106.3 cents on the dollar, Trace data show.

Sales Drop

“You're seeing cash come into this market hand over fist,” PeterToal, the head of Americas leveraged finance syndicate at Barclaysin New York, said in a telephone interview. “When you have dealsthat are multiple times over- subscribed, you can't feedeverybody.”

High-yield bond issuance has slowed as Europe's debt crisisintensified and a weakening U.S. economy deterred companies fromraising money. Sales declined to a monthly average of $13.8 billionin May and June from $29.9 billion of debt in January throughApril.

Cash-like investments accounted for an average 7.7 percent ofhigh-yield bond funds' assets at the end of June, 2.6 percentagepoints more than a year earlier, according to data from theInvestment Company Institute in Washington.

“As the inflows have accelerated, the competitiveness of biddersfor new issues has intensified,” Fridson said. “It's not easy tobuy the paper you want to buy in the secondary market becausethings have been tight for a while and so that makes the new-issuemarket the place to put money to work.”

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