Chasing yield, investors favour credit again in 2013
The desperate hunt for yield will continue in 2013, with investor money continuing to flow into high yield ‘junk’ bonds, corporate debt and mortgage securities as it has this year, albeit with lowered expectations on returns.
According to a dozen money managers at the Reuters Global Investment Outlook 2013 Summit, the Federal Reserve's commitment to hold rates near zero until at least mid-2015 provides ample buying support for corporate credits.
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This year, junk bonds and corporate debt markets have seen strong demand as the ferocious hunt for yield shows no signs of slowing with the JPMorgan Global HY index's year-to-date return up 14.22 per cent and the JPMorgan IG index return up 9.8 per cent.
Returns from investments in those securities are now coming down significantly, forcing some money managers to get out of their comfort zones and take on much more risk than they would otherwise.
“The economy still show signs of slowing. Europe’s problems seem intractable," said Bonnie Baha, senior portfolio manager of DoubleLine Capital. “Swinging for the fences strikes me almost as foolhardy at this point in the game."
But it doesn’t look like the game is about to end. So far this year, bond funds, including ETFs, have taken in over $283 billion, according to Lipper data. In comparison, mutual fund-only outflows from equities is $62 billion, though an improvement over last year's $94 billion outflow.
Steven Einhorn, vice chairman of Omega Advisors, a $7 billion hedge fund founded by industry veteran Leon Cooperman, said the party in bonds will end “when investors begin losing money. You will then see these flows reverse. I don't think it is imminent because of monetary policy at around zero."
Juice left in ‘junk’
In September, both the European and US central banks unveiled new bond buying programs. The massive monetary stimulus plans, which include very low short-term interest rates, have depressed yields on US government debt to near record lows.
“There is such a lack of risk in the financial system right now," said David Schawel, a fixed income portfolio manager and writer for Economic Musings. “Are rates really going to spike up four or five per cent overnight?"
Junk bonds yielding in the high-single digits still provide an attractive opportunity with defaults on the decline.
“In fixed income, we are virtually all in high-yield," said Margaret Patel, managing director at Wells Capital Management. “It still has the best risk reward" compared to Treasuries and investment-grade bonds, she said. “It is hard for me to see a big back-up in any fixed income investment, so why not get the extra yield?"
But not every investor is ready to jump into the deep and murkier end of the credit pool yet.
DoubleLine, the $50 billion bond firm founded by Jeffrey Gundlach, has favoured residential non-agency, mortgage-backed securities (RMBS) through 2012, said Baha.
Now, the firm is looking at commercial mortgage-backed securities (CMBS) to help raise returns in 2013.
“The talk of CMBS has been floating around the office," Baha said, noting that while there is still an opportunity to make money in RMBS, the “more obvious trades have been completed."
DoubleLine recently added to CMBS portfolio exposure in both its DoubleLine Total Return Bond and DoubleLine Core Fixed Income Fund. CMBS exposure in the Core Fixed Income Fund portfolio is now approximately seven per cent.
This year through October, mortgage-focused hedge funds have gained 13.3 per cent, according hedge fund tracking firm eVestment|HFN. Credit-focused hedge funds in general have performed well, gaining more than 10 per cent through October.