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With interest rates at record lows, investors have been forced to plumb the depths of the junk bond market in desperate search of yield.
The result has seen liquidity in the high yield market shrink to a level that hasn’t been seen for over 20 years according to Fraser Lundie, co-head of credit at Hermes Fund Management in London.
Lundie says that “investors must try to diversify to reduce this risk” and has developed four golden rules for high yield investors to follow. Courtesy of Investment Week:
1. Avoid Callable Bonds. – Lundie says, “some three-quarters of global high yield issuance has an embedded call.” This is an attractive option for companies who can use the call to refinance their bonds at a lower price. This refinancing effectively puts a ceiling on how far such bond yields can rise.
2. Use Credit Default Swaps (CDS). – Credit Default Swaps act like an insurance policy in the current environment. Such instruments offer bond returns without the interest rate risk, and are trading at par. He noted high yield liquidity remains tight, hampered by post-crisis regulations and a growing universe. As such, CDS offer better liquidity, he said.
3. Look for Diversified Funds. – Investors should look at funds that are more diversified, according to Lundie. He says investors are better off in a fund with a barbell exposure between BBs and CCCs.
4. Diversification. – Investors should cast their net as widely as possible. Many global high yield allocations are too constrained, and may not be able to invest in CCC-rated bonds or CDS or are restricted to only bonds issued in dollars or euros.
Todays Other Top Stories
Caprin Asset Management: – Bonds: Now What? – With all the coverage about the Great Rotation and the possibility of ‘Sep-taper’, bond investors seek insight on how to position portfolios given new yield curve drivers. Investors in longer dated and/or credit sensitive funds have been challenged since May. But that is not how your Caprin strategy invests. Our intermediate investment solutions seek a Capital Preservation and Income balance, and here are some perspectives on our current thinking.
FT: – Bond yields defy forward rates guidance. – Bond markets are more likely to be right than economists. But central bankers are economists with monetary weaponry. Those selling bonds need to be sure central bankers will not back up their words with action.
Learn Bonds: – Corporate bond default loss risk quantification made simple. – In this article I will try to derive what default loss risk percentages should be applied in evaluating specific bonds (i.e., bonds with different credit ratings, years to maturity or call, and lien [seniority/subordination] positioning). I will also present a default loss risk quantification system that is both simple and relatively accurate.
Emmanuele Marrot: – Should you invest in Lending Club: A statistical analysis. – bond returns are frustrating low, and an alternative has recently emerged: ‘Peer to Peer lending’. P2P lending relies upon Internet as an intermediation platform, to lend (relatively) small amounts to numerous borrowers. Thanks to the law of large numbers, spreading the invested money over hundreds or thousands of borrowers significantly reduces the risk. Unless they’re all correlated, as the Housing crash showed, but that’s a different story…
Financial Adviser: – Five bond diversification strategies. – The challenge for advisors now is to find a way to diversify their clients’ interest rate exposure without severely disrupting the portfolio’s income stream and risk/reward profile.
Courier Journal: – 5 questions and answers about bonds. – Although rising interest rates are bad news for bondholders, investors shouldn’t tar all bond funds with the same brush, says Eric Takaha of Franklin Templeton. Takaha is the co-lead manager of the Franklin Strategic Income fund, which invests in a wide range of bonds, and bond-like securities, both in the U.S. and overseas.
Cerebro: – U.S. Fixed Income ETF Portfolio. – Retail investors have to make do with tools which are insufficient to compete with institutions. Retail investors need to abide by a different set of rules and systems. As such here’s a strategy and portfolio tailored for retail investors.
FT: – Blockbuster Verizon bond sale to test debt appetite. – A blockbuster bond sale by Verizon, the US telecoms group, is about to make Apple’s recent record offering look a light bite. For the global bond market, the timing is not good. The sale is shaping up to be a big test of investors’ appetite just as a multi-year rally judders to a halt.
Forbes: – Do you have the next Detroit in your muni fund? – Would you want to lend money to a place like this? Unemployment is 14%, a third of the population is on welfare, debt ratios are worse than in Illinois and the murder rate is six times that of the U.S.
Financial Adviser: – Is it time to buy munis. – Craig Henderson has been managing municipal bonds for 23 years, so it’s no surprise he favors them. And right now, he may like them more than ever, and not surprisingly, he’s buying.
The Fiscal Times: – Munis are suffering their worst month since 2008. – The Treasury bond market may be dominating the headlines, as investors fuss and fret over the timing of an end to the Federal Reserve’s ultra-accommodative monetary policy. But the folks at S&P Dow Jones Indices reminded us today that the real pain is being felt by those who own municipal bonds.
Investment Week: – Kames bond managers add to long-dated bonds as yields rise. – Kames Capital fixed income specialists David Roberts and Philip Milburn are seeing value return to long-dated bonds following the recent spike in bond yields.
FT: – Bonds taper tantrum turns to ‘hike huff’. – The bonds sell-off that began when the Federal Reserve signalled it would soon wind down its emergency asset-buying has become known in markets as the “taper tantrum”. We might now be in a new phase: the “hike huff”.
Barron’s: – Muni funds lose $1.3 billion in 15th straight weekly loss. – Municipal bond mutual funds and exchange-traded funds posted yet another weekly net outflow, per Lipper data, reporting $1.30 billion in investor withdrawals in the week ended Wednesday, a small improvement on the $1.74 billion outflow seen a week earlier.
Trustnet: – The areas still offering value in the bond market. – Income investors have been tearing their hair out watching their cash savings erode in real terms as interest rates from high street banks shrivel up to next to zero. But making the big leap from a seemingly safe investment such as cash straight into equities can often feel like “passing go” and not collecting £200 on the way.
Bond Buyer: – Gallagher’s ‘blood oath’ to keep focus on munis. – Securities and Exchange Commission member Daniel Gallagher has sworn to take up the cause of municipal market reform at the SEC, accepting the baton from Elisse Walter, who recently left the commission.
WSJ: – Muni advisers face tougher SEC rules. – Regulators are set to finalize long-delayed rules to rein in advisers who help states and localities raise cash in the $3.7 trillion municipal-bond market, a move aimed at protecting taxpayers from the types of complex transactions that soured during the financial crisis.
Stamford Advocate: – Pierpont exits high-yield debt trading as 11 depart in past week. – Eleven people departed Pierpont Securities during the past week as the broker-dealer decided to stop trading speculative-grade debt.
US bond yields dropping like a stone. US 10 year down to 2.87 pct
— Chris Adams (@chrisadamsmkts) September 6, 2013