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Experts have cautioned that bond managers are playing a dangerous game with high-yield investments given stretched valuations and the “intense lack of liquidity” facing the asset class.
Tom Becket, chief investment officer at Psigma Investment Management, told the Financial Times the “intense lack of liquidity in corporate bond markets” is one of the main problems managers face.
This lack of liquidity makes it difficult for managers to exit quickly once investors start to rush for the exit. Those who do not get out in time could face significant problems.
Becket went on to say a reversal in sentiment could send such a shock through markets that it could even affect equities. Added that the “huge appetite” still present for bonds will continue to support markets for now, but he said “you want to get out before the party ends”.
Morningstar OBSR investment strategist Andy Brunner also said managers who try to squeeze every last drop of performance from high-yield debt may find it difficult to sell out amid a correction.
Mr Brunner said investors need to question whether they are being compensated for the “substantial liquidity risk” in holding corporate bonds.
He explained that, without a stock exchange for bonds, trades are facilitated over the counter, but he pointed out that liquidity is drying up and “turnover in American high-yield bond markets is less than half what it was in 2007”.
Mr Brunner concluded that most market participants are now “hugely overweight an asset where the potential for excess returns has declined significantly and where liquidity is a major issue”.
Todays Other Top Stories
LearnBonds: – 5 Ways Fed policy may be hurting the economy. – Financial Lexicon looks at five reasons Fed policy may be hurting the economy and why the fed will have such a hard time fully reversing its ultra-easy monetary stance.
ValueWalk: – The municipal bond world, according to John Derrick. – Director of Research John Derrick, gives his thoughts on interest rates, the bond market and what investors should pay attention to as we move into the second quarter of 2014.
ETF Trends: – ETF spotlight: California munis. – ETF Spotlight on the SPDR Nuveen Barclays California Municipal Bond ETF (NYSEArca: CXA).
Bullfax: – Puerto Rico bonds send ex-champ to the ropes. – Former boxing champion Felix Trinidad is still punching, trying to recover losses he says exceed $63 million from investing in Puerto Rican municipal-bond funds.
Businessweek: – Detroit’s legacy seen in bondholder security demand: Muni credit. – Even with the municipal market gaining the most since 2009, a shift is afoot one year after Detroit’s record bankruptcy: More than ever, bonds’ security pledges weigh on investment decisions.
Barron’s: – Global risk reappears, bonds benefit. – Geopolitical risk flared anew last week, and government bonds were the big beneficiaries, forestalling yet again the long-anticipated rise in Treasury yields.
Bloomberg: – U.S. bonds longer than 30 years would face hurdles, dealers say. – Efforts by the Treasury to sell bonds due in more than 30 years would face obstacles as the Federal Reserve begins raising interest rates from a record low, according to dealers that underwrite U.S. debt sales.
High Yield Bonds
Stl Today: – Gallagher: Should we bail on junk bonds and small caps? – Federal Reserve Chairman Janet Yellen went to Congress last week and threw darts at little bubbles. We small investors should watch out.
Zero Hedge: – High yield bonds are flashing red again. – There is a glaring divergence between the performance of US equities and high-yield credit spread over investment-grade credit. As BofAML warns, “either HY rallies or stocks soon in a bit of trouble,”because the only pillar left to hold up the fragile un-bubble-like stock market – buybacks – will disappear if costs of funding start to surge (there’s always a limit to the leverage a credit cycle will bear).
Businessweek: – Ex-Jefferies bond trader anticipates junk swoon. – Fiera Quantum, one of the winners of the meltdown in Canada’s asset-backed commercial paper market, is looking for its next trade idea in junk bonds.
Chris Puplava: – The first victims of the end of QE – Small cap stocks and junk bonds. – Small cap stocks have underperformed large cap stocks by nearly 10% this year. Junk bonds are also underperforming investment grade bonds. Contracting margin debt associated with weakness in riskier areas of the market. Coming end of QE and first Fed rate hiking coming into view calls for investor caution ahead.
MarketWatch: – A junk-bond warning: Investors exit as yields rise. – Weeks of falling junk bond prices have started to spook some bond investors, signalling that the record run for the riskiest part of corporate debt may be ending.
Bloomberg: – That record Pimco junk outflow shows investors’ anxiety. – Bond buyers are sending a loud message this month: They want a break from the riskiest securities.
Wealth Management: – What risks are worth taking in the bond markets now? – We think bond investors are not being adequately compensated for taking on interest-rate, credit or liquidity risk in the current market environment. This begs the question: What risks are worth taking in the bond markets if these traditional risks are overvalued?
FT.com: – Emerging market debt issuance hits record high. – Emerging and frontier market countries have borrowed a record amount of money in capital markets in the first half of this year, even as central bankers warn that “debt market euphoria” could be storing up trouble for the future.
Business Insurance: – Catastrophe bonds are on track for a record year. – A record $4.5 billion in catastrophe bonds issued in the second quarter of this year shows the alternative risk transfer method is maturing amid strong investor demand and limited losses.
ETF.com: – Investors pile into bond ETFs for week. – Investors added $1.8 billion to the ETF market in the past week ended Thursday, July 17, but tensions between Israel and Palestine and the downing of a commercial airliner in Ukraine yanked stock prices lower, pulling U.S.-listed ETF assets downward too.
Market Realist: – A must-know guide to interest rates and your investments. – With interest rates expected to rise from their record lows, investors are flocking to equities and high yield securities in search of returns. However, investors are cautious in choosing fixed income investments given the potential for further rate increases as the economy continues to expand. This series examines the factors affecting interest rates and how fixed income investments can respond as rates rise.
Forbes: – Best ETFs for traders: Short-term bonds. – Are you awaiting the next market correction with a pile of cash? You could invest it in a money market fund and pull down a yield of 0% before inflation and perhaps -2% after. Or you could take a bit of risk on a short-term bond fund. This list has the best deals among short-term bond ETFs.
Forbes: – Best ETFs for traders: Long-term bonds. – This list of cheap ETFs covers the ones holding long-term bonds. You’d buy one of these things if you want to make a quick bet that interest rates will go down. Cheapness, here, is measured over the hot-potato holding period of three months.
Barron’s: – Searching for bargains in closed-end funds. – Closed-end bond funds have been on a tear this year, returning an average of 11% during the first half, including dividends, according to Closed-End Fund Advisors, a research group. The average yield at the end of June was 6.4%. Compare that with a first-half total return of just 5.4% for SPDR Barclays High Yield Bond (ticker: JNK), an exchange-traded fund that tracks junk bonds.
Zacks: – Zacks #1 ranked government bond mutual funds. – We will share with you 5 top rated government bond mutual funds. Each has earned a Zacks #1 Rank (Strong Buy) as we expect these mutual funds to outperform their peers in the future. To view the Zacks Rank and past performance of all government bond funds.
“If the Fed was too loose and behind the curve, the yield curve would not be flattening and zeros would not be outperforming stocks by 4x”
— modest proposal (@modestproposal1) July 21, 2014
EM sovereign bond issuance of ~$70bil YTD, up 54% compared to the same period in 2013 — David Schawel (@DavidSchawel) July 20, 2014
Janney: Tax-exempt technicals are looking decent, with issuance a healthy $5.8 billion this week and flows turning positive #muniland
— Cate Long (@cate_long) July 21, 2014