Fears rise over headlong hunt for yield
Institutional investors are being urged to review the quality of bond issues across the credit spectrum amid fears that the search for yield in this low-rate environment is leading to indiscriminate buying.
Valuations have become stretched in certain high-yield bond markets, with spreads having tightened by 50 basis points since last year to 360bp, although they are still some way off 2006-07 levels of 250-300bp, argued panelists at a recent forum.
“If asked how I would be managing my high-yield at the moment, it would likely be in an active way. I would be using qualitative techniques to analyse the issuers,” says Kevin Anderson, head of investments for Asia Pacific at State Street Global Advisors.
He was speaking on a panel on asset management strategies at the fifth annual Borrowers and Investors Forum hosted by Haymarket Media, parent of AsianInvestor.
“We are seeing a number of 'covenant-lite' loans emerging, which are less friendly to bond holders, and I would not be indiscriminately buying them," adds Anderson. "I would be analysing if they were worth the yield. There is still value in high yield, but be aware of what you are buying.”
Asked if there was a risk of the market heading back to 2006-07 levels, he did not dismiss the notion, but argued there is not the same degree of leverage in the market as before. He added it had become more important for liability-driven investors to scour for value in safe-haven assets.
Jackson Loi, head of institutional sales for Hong Kong and Taiwan at Vanguard Investments, said the absolute level of yield had been far higher in 2007. “In terms of how we manage high-yield performance now, we would seek an actively managed strategy and would position that to focus on the higher-quality spectrum, mainly BB and single B, which are relatively more attractive than CCC.”
Anderson acknowledged the risk that the market was in danger of getting ahead of itself, having priced in a rise in 10-year US Treasury yields to 325bp by the year’s end, from 270bp now. “If we see continued focus on strong US consumer numbers, the market could get ahead of itself. That is a bigger risk than bond yields falling, certainly,” he said.
Geoff Lunt, investment director at HSBC Global Asset Management, noted that institutional investors were being squeezed from both ends: not only finding it difficult to find the yield they require, but also faced with an indiscriminate search for yield in an environment where liquidity may become less abundant.
He referred to “the tyranny of benchmarking”, particularly in fixed income, noting that investors had become aware that cap-weighted indices were inappropriate and had moved towards a dynamic total return approach.
Asked how Asian insurers were dealing with the challenge of matching assets to liabilities, given that duration in local bond markets is not really there to allow them to hedge, Lunt replied: “It’s simple, they run a mismatch.”
Loi noted that Taiwanese insurers were among those liability-driven investors looking to increase their overseas fixed income exposure to target deeper market liquidity at longer durations, accepting the need to manage exchange-rate risk.
Anderson suggested that there was duration at the long-end of the Thai, Malaysian and Indonesian curves, but agreed that was often at the expense of liquidity.
Nevertheless he observed that the liquidity of these markets had vastly improved from 10 years ago, partly because there are now more foreign investors in local-currency Asian bond markets.
“Although Asian sovereigns may not have done enough to help insurers hedge their liabilities, there is greater two-way access at the long-end of the market now compared with 10 years ago,” he said. “It is not completely a buy-and-hold market for pension funds and insurance funds, so there are some chinks of light at the end of that tunnel.”
Loi agreed that Asian institutions had been moving away from traditional benchmarks towards more risky exposures such as credit, at the expense of duration. He said he expected them to increase their exposure more to Asian fixed income, including RMB, to be better aligned with the local environment, inflation and currency.
Asked if it was advisable for long-term investors to be moving into shorter-term exposures, Lunt said some characteristics of short-duration strategies were very attractive, including in high yield.
“High-yield bonds are more likely to default after issuance than when they are seasoned,” he said. “From that point of view, not only do you get decent yield carry, but you also get a lower likelihood of default historically.”
Overall the panelists agreed that equities were likely to outperform bonds in 2014. But Anderson said it was not a straight-line equation for institutions simply to overweight equity strategically and expect it to outperform.
He highlighted the importance of dynamic allocation between risky and less risky assets, combined with assets with low correlation to traditional holdings, such as alternatives. “That is going to be what helps institutional investors meet their return targets this year.”
Lunt said one of the reasons the great rotation from fixed income into equities did not happen last year was that many institutions simply could not handle the volatility of the equity markets.
“From that point of view, the bond markets remain well underpinned, especially as we move into a world of ageing populations where longer-duration assets are going to be very much in demand and inflation is likely remain low,” he added.
While some developed-market equities are looking expensive, Loi said he expected a re-allocation among institutions of 5-10%, which he acknowledged would have a meaningful impact on portfolio risk. He said investors were looking for income stability at lower volatility, with many favouring a high-dividend yield portfolio.
Asked what position floating-rate bonds might be taking in institutional asset allocation, Lunt expressed doubt about the liquidity of the market. These types of securities would not solve the issue of low yields, he argued, given that issuers of floating-rate notes are generally of high credit quality.
Loi said he had seen a number of institutions start to show interest in leveraged loans, notably in Japan. But Anderson pointed to issues over transparency, and the fact that there is not a very strong secondary market for some of these instruments.