AUGUST 28, 2010
By BEN LEVISOHN
In the surging bond market of 2010, what began as a quest for safety is quickly morphing into a grab for yield. If investors aren't careful, they could end up with neither.
With short-term Treasury rates plummeting—the two-year note's yield touched a record low of 0.454% on Aug. 17—investors have been looking for other ways to juice their returns.
Not only are they gobbling up long-term government bonds, they also are feasting on the debt of low-rated companies. During the past three months, 30-year Treasurys have jumped by 8.5%, while so-called junk bonds have risen by 6.5%. Their yields, which move in the opposite direction of price, have fallen accordingly.
Eager to feed investors' appetites, companies issued a record $15.4 billion in junk bonds the week ended Aug. 13, the most since at least 1997. Norfolk Southern Corp., an investment-grade railroad, even sold $250 million in 100-year bonds on Aug. 23, and there is talk of more century deals to come.
Major Risks
But both long-term Treasurys and junk bonds have major risks. While 30-year Treasurys boast low "credit risk," or the likelihood that the investor won't get paid back, they carry high "duration risk," because their long maturity means there is more of a chance for inflation to erode returns. Junk bonds, meanwhile, have shorter terms and therefore are much less sensitive to fluctuating interest rates—but they carry high credit risk.
Either play, on its own, can be dangerous. When 10-year Treasury yields rose 2.5 percentage points from 1993 to 1994, the value of long-term Treasurys dropped by more than 5%. Junk bonds, meanwhile, lost 7% from their 1999 peak to their 2000 trough. When the financial system imploded in 2008, junk bonds fell by a staggering 35%.
It is important not to confuse the current hunt for yield with the excesses of the mid-aughts. By 2007, the difference between a junk bond and a U.S. Treasury had fallen to 2.75 percentage points, the lowest since at least 1987; it now is about 6 points, near its historical average.
Even after the recent drop in 30-year Treasury yields, from 4.63% at the beginning of the year to about 3.68% now, the difference between the long bond and overnight rates is still 1.6 percentage points above its historical average, according to Gluskin-Sheff chief economist David Rosenberg.
Still, those spreads have narrowed considerably. By chasing the best-performing bond sectors, investors risk overloading their portfolios and leaving themselves exposed should economic growth prove stronger or weaker than expected.
Guggenheim Partners, which manages money for institutions and high-net-worth investors, has been betting on both long-term Treasurys and junk bonds—but in different ways.
It has put about half of its portfolio in long-term Treasurys and other government debt. (It prefers 15-year zero-coupon bonds, which have a similar duration to 30-year Treasurys.) It is putting the other half in the short-term debt of junk-rated companies that have cash or access to it. Even if the economy continues to deteriorate, most of these companies should have the wherewithal to pay back the principal when the bond matures, says Guggenheim Chief Investment Officer Scott Minerd.
Mr. Minerd says the strategy yields about 5.5% now—more than twice a 10-year Treasury bond, with similar duration risk.
"If rates continue to fall, I get a lot of price appreciation out of the zeros," Mr. Minerd says. "But if rates go higher, 50% of my portfolio turns into cash in a year and I get the opportunity to reinvest at higher rates."
One of Guggenheim's junk holdings is an Eastman Kodak Co. bond maturing in November 2013, which yields about 9%. The fallen blue chip had $1.3 billion on its balance sheet as of June, more than twice as much as the debt coming due.
Seeking Diversification
Still, the strategy carries enough duration and credit risk for safety-minded investors to be wary. For those who seek even more diversification, J.P. Morgan Private Bank has set up a portfolio of assets that tend not to move in the same direction, which it has dubbed the Dynamic Yield Strategy.
The portfolio currently consists of 12% short-term government bonds, 17.5% high-yield bonds, 6% emerging-market debt, 10% floating-rate bank loans, 5% convertible bonds, 7.5% "call" and "put" options, 20% global macro hedge funds, 10% dividend-paying stocks, 10% "credit-spread strategies" and 2% in cash.
The result is a portfolio that yields about 3.4%, nearly one percentage point more than a 10-year Treasury, with one-quarter the exposure to a rise in interest rates, says J.P. Morgan.
"There's no doubt there's a huge search for yield," says Jamie Kramer, head of thematic advisory at the bank. "But it's better to be smart about the risks you're taking."
From The Wall Street Journal published on Thursday, August 28, 2010
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Bond funds: Why they're risky -- and why they're safe
Bond funds have been a popular investor choice in recent weeks, but some investment gurus warn of a bond-fund bubble that will burst. Here's the case for and against bond funds.
By Mark Trumbull, Staff writer / August 24, 2010
Investors poured money into bonds Tuesday, as worries about the economy battered the stock market.
The rush into bond funds amplifies a trend that's been largely in place since the financial crisis began, but it raises an important question: At this point, are people playing it safe or risky when they emphasize bonds over stocks in their retirement funds?
Some investment gurus warn of a bond-fund bubble that will burst – hitting US Treasury bonds hardest of all – perhaps within the next year. A rival camp sees the big risks in stocks in the near term. Given the uncertainty, a middle-ground view emphasizes the virtues of a balanced mix of bonds and stocks.
Mutual-fund investors continue to vote with their feet for bonds. In each of the five weeks ending Aug. 11, they poured more than $6 billion into bond funds. And in each of those weeks, investors were pulling money out of stock mutual funds at a rate of $1 billion to $4 billion per week, according to the Investment Company Institute in Washington.
On Tuesday, falling home sales and other signs of economic weakness sent stock prices falling and prompted an investor rush toward bonds. The yield on the 10-year Treasury note fell to just 2.5 percent, the lowest since early 2009. (The yield on a bond falls as its price rises. In effect, rising demand means that investors are willing to settle for a smaller stream of income.)
Here's the case for and against bond funds:
Why bond funds are risky
Although bonds are less volatile in price than stocks, they can fluctuate considerably at turning points in the economy. If the economy turns up, even just enough to clearly avoid a "double dip" recession, bond prices could suffer as investors begin to gravitate back toward the stock market.
It's hard to predict when a shift will occur, but at some point, many investment strategists warn, Treasury bonds will become the worst-performing bonds of all. That's precisely because these bonds are considered to be among the safest investor havens during hard times. If a crisis mind-set eases, Treasuries have run up so far in price that they have the furthest to fall.
"The US is in the midst of a sharp but temporary slowdown that will give way to stronger growth later this year and into 2011," Michael Darda, chief economist at the investment firm MKM Partners, wrote in a note to clients Monday. That makes him bullish on stocks.
A revival of inflationary pressure would pose another worry for bonds. Interest rates might rise as investors demand a higher return to compensate them for inflation. The prices of existing bonds would adjust downward accordingly.
One example of how vulnerable bond funds can be when the mood toward bonds shifts: The Fidelity Government Income Fund, which invests mostly in US government bonds (ticker symbol FGOVX), saw its share price fall 13 percent during a six-month period starting late in 1993. The sell-off in bonds came just before a period of massive gains for stock investors.
Since the onset of the financial crisis in 2007, a Barclays exchange-traded fund that tracks long-term US Treasury bonds has gained more than 20 percent in value. This bond fund (ticker symbol TLH) has risen so sharply since March that it's currently near the peak it reached at the end of 2008.
Why bond funds are safe
The bullish view is that bond funds have risen for a good reason: The outlook for the economy has grown worse than investors had foreseen a few months ago. Although US stocks have lost more than 10 percent of their value since April, they could easily fall a lot further if the economy keeps getting worse.
Treasury bonds, the same ones that critics say are in a bubble, tend to perform the best during a crisis. Put another way, even though stock and bond prices can often move in the same direction, Treasuries tend to be more protected from a stock bear market than, say, corporate bonds are.
The bond-bull camp doesn't foresee a big sell-off in bonds until the economy mounts a strong recovery. And in its view, that could take more than a year. In the meantime, bond investors will earn at least a modest income – more than they could get in money-market mutual funds that are often yielding nearly zero percent interest.
In this view, inflation won't get going anytime soon. That's because the economy's troubles stem from over-indebted consumers, troubled banks, and a government that may be running out of stimulus options. In other words, this hasn't been a garden-variety recession and won't be a typically strong recovery either. (Inflation tends to appear during a robust recovery.)
What about when an economic recovery does kick in?
Bonds won't tank overnight. Even if investors do experience a bear market in bonds, some research offers a brighter view of what occurs: If bond-fund investors stay the course, argues a report issued by Vanguard, a big provider of mutual funds, the losses in portfolio value if bond prices fall would ultimately be offset by rising income from their bond funds.
Of five hypothetical scenarios that Vanguard researchers examined, the one with the biggest shareholder loss in the short term (one year) was also the one with the highest annualized returns over a 10-year period.
Follow the bond bulls, bears, or both?
Both sides in this bond-fund debate have some strong arguments. One option for investors is not to side wholly with either camp.
To many investment strategists, the prudent course for people saving for retirement is to hold a balanced mix of stocks and bonds. It's a classic view, based on the notion that stocks have provided stronger returns than bonds during most periods, while bonds add some stability without dragging long-term performance down too much.
From The Christian Science Monitor published on AUGUST 24, 2010
By Mark Trumbull, Staff writer / August 24, 2010
Investors poured money into bonds Tuesday, as worries about the economy battered the stock market.
The rush into bond funds amplifies a trend that's been largely in place since the financial crisis began, but it raises an important question: At this point, are people playing it safe or risky when they emphasize bonds over stocks in their retirement funds?
Some investment gurus warn of a bond-fund bubble that will burst – hitting US Treasury bonds hardest of all – perhaps within the next year. A rival camp sees the big risks in stocks in the near term. Given the uncertainty, a middle-ground view emphasizes the virtues of a balanced mix of bonds and stocks.
Mutual-fund investors continue to vote with their feet for bonds. In each of the five weeks ending Aug. 11, they poured more than $6 billion into bond funds. And in each of those weeks, investors were pulling money out of stock mutual funds at a rate of $1 billion to $4 billion per week, according to the Investment Company Institute in Washington.
On Tuesday, falling home sales and other signs of economic weakness sent stock prices falling and prompted an investor rush toward bonds. The yield on the 10-year Treasury note fell to just 2.5 percent, the lowest since early 2009. (The yield on a bond falls as its price rises. In effect, rising demand means that investors are willing to settle for a smaller stream of income.)
Here's the case for and against bond funds:
Why bond funds are risky
Although bonds are less volatile in price than stocks, they can fluctuate considerably at turning points in the economy. If the economy turns up, even just enough to clearly avoid a "double dip" recession, bond prices could suffer as investors begin to gravitate back toward the stock market.
It's hard to predict when a shift will occur, but at some point, many investment strategists warn, Treasury bonds will become the worst-performing bonds of all. That's precisely because these bonds are considered to be among the safest investor havens during hard times. If a crisis mind-set eases, Treasuries have run up so far in price that they have the furthest to fall.
"The US is in the midst of a sharp but temporary slowdown that will give way to stronger growth later this year and into 2011," Michael Darda, chief economist at the investment firm MKM Partners, wrote in a note to clients Monday. That makes him bullish on stocks.
A revival of inflationary pressure would pose another worry for bonds. Interest rates might rise as investors demand a higher return to compensate them for inflation. The prices of existing bonds would adjust downward accordingly.
One example of how vulnerable bond funds can be when the mood toward bonds shifts: The Fidelity Government Income Fund, which invests mostly in US government bonds (ticker symbol FGOVX), saw its share price fall 13 percent during a six-month period starting late in 1993. The sell-off in bonds came just before a period of massive gains for stock investors.
Since the onset of the financial crisis in 2007, a Barclays exchange-traded fund that tracks long-term US Treasury bonds has gained more than 20 percent in value. This bond fund (ticker symbol TLH) has risen so sharply since March that it's currently near the peak it reached at the end of 2008.
Why bond funds are safe
The bullish view is that bond funds have risen for a good reason: The outlook for the economy has grown worse than investors had foreseen a few months ago. Although US stocks have lost more than 10 percent of their value since April, they could easily fall a lot further if the economy keeps getting worse.
Treasury bonds, the same ones that critics say are in a bubble, tend to perform the best during a crisis. Put another way, even though stock and bond prices can often move in the same direction, Treasuries tend to be more protected from a stock bear market than, say, corporate bonds are.
The bond-bull camp doesn't foresee a big sell-off in bonds until the economy mounts a strong recovery. And in its view, that could take more than a year. In the meantime, bond investors will earn at least a modest income – more than they could get in money-market mutual funds that are often yielding nearly zero percent interest.
In this view, inflation won't get going anytime soon. That's because the economy's troubles stem from over-indebted consumers, troubled banks, and a government that may be running out of stimulus options. In other words, this hasn't been a garden-variety recession and won't be a typically strong recovery either. (Inflation tends to appear during a robust recovery.)
What about when an economic recovery does kick in?
Bonds won't tank overnight. Even if investors do experience a bear market in bonds, some research offers a brighter view of what occurs: If bond-fund investors stay the course, argues a report issued by Vanguard, a big provider of mutual funds, the losses in portfolio value if bond prices fall would ultimately be offset by rising income from their bond funds.
Of five hypothetical scenarios that Vanguard researchers examined, the one with the biggest shareholder loss in the short term (one year) was also the one with the highest annualized returns over a 10-year period.
Follow the bond bulls, bears, or both?
Both sides in this bond-fund debate have some strong arguments. One option for investors is not to side wholly with either camp.
To many investment strategists, the prudent course for people saving for retirement is to hold a balanced mix of stocks and bonds. It's a classic view, based on the notion that stocks have provided stronger returns than bonds during most periods, while bonds add some stability without dragging long-term performance down too much.
From The Christian Science Monitor published on AUGUST 24, 2010
Japan REIT Bond Market Thaws, Still Faces Risks, Fitch Says
August 23, 2010, 6:07 AM EDT
By Yusuke Miyazawa
Aug. 23 (Bloomberg) -- Japan’s real-estate investment trust bond market is starting to thaw after two years as the economy rebounds, though property prices would need to rise for a full recovery, according to Fitch Ratings.
“New bond sales are recovering to some extent,” Toru Kobayashi, Tokyo-based director of structured finance at the risk assessor, said in an interview at his office. Some REITS still face risks, he said. These need to see “improvements in property performance.”
Sales of REIT bonds this year totaled 124.5 billion yen ($1.46 billion), recovering from a single public sale of 3 billion yen in 2008 and none in 2009, according to data compiled by Bloomberg. The Tokyo Stock Exchange REIT Index has gained 0.6 percent this year, while the Topix index has dropped 9.1 percent.
Land prices started falling in 2008 as the global crisis deepened with the collapse of Lehman Brothers Holdings Inc., previously a lender to property investors. New lending for real estate by Japan’s banks fell to the lowest in a decade in 2009, according to the Bank of Japan.
“Among some borrowers with a smaller size or inferior financial standings, we see extension of short loans or finance in the short term,” Kobayashi said. “Such REITs haven’t eased their finance risk.”
Japanese real estate asset manager Urban Corp. filed for bankruptcy in August 2008. Japan’s Ministry of Land, Infrastructure, Transport and Tourism said in August 2009 that a 500 billion yen fund would be formed to help REITs refinance their debt.
Tokyo’s office vacancy rate fell in July for the first time in 2 1/2 years, to 9.1 percent from a record high of 9.14 percent in June, according to Miki Shoji Co., a privately held office brokerage.
The extra yield investors demand to own Japan Prime Realty Investment Corp.’s 1.71 percent bonds due May 2011 instead of similar-maturity government debt averaged 0.7 percentage point yesterday, according to Japan Securities Dealers Association prices. It was as high as 2.11 percentage points in April 2009, the prices show.
--Editors: Tom Kohn, Andreea Papuc
To contact the reporters on this story: Yusuke Miyazawa in Tokyo at ymiyazawa3@bloomberg.net.
To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net.
From Bloomberg Businessweek published on August 23, 2010, 6:07 AM EDT
By Yusuke Miyazawa
Aug. 23 (Bloomberg) -- Japan’s real-estate investment trust bond market is starting to thaw after two years as the economy rebounds, though property prices would need to rise for a full recovery, according to Fitch Ratings.
“New bond sales are recovering to some extent,” Toru Kobayashi, Tokyo-based director of structured finance at the risk assessor, said in an interview at his office. Some REITS still face risks, he said. These need to see “improvements in property performance.”
Sales of REIT bonds this year totaled 124.5 billion yen ($1.46 billion), recovering from a single public sale of 3 billion yen in 2008 and none in 2009, according to data compiled by Bloomberg. The Tokyo Stock Exchange REIT Index has gained 0.6 percent this year, while the Topix index has dropped 9.1 percent.
Land prices started falling in 2008 as the global crisis deepened with the collapse of Lehman Brothers Holdings Inc., previously a lender to property investors. New lending for real estate by Japan’s banks fell to the lowest in a decade in 2009, according to the Bank of Japan.
“Among some borrowers with a smaller size or inferior financial standings, we see extension of short loans or finance in the short term,” Kobayashi said. “Such REITs haven’t eased their finance risk.”
Japanese real estate asset manager Urban Corp. filed for bankruptcy in August 2008. Japan’s Ministry of Land, Infrastructure, Transport and Tourism said in August 2009 that a 500 billion yen fund would be formed to help REITs refinance their debt.
Tokyo’s office vacancy rate fell in July for the first time in 2 1/2 years, to 9.1 percent from a record high of 9.14 percent in June, according to Miki Shoji Co., a privately held office brokerage.
The extra yield investors demand to own Japan Prime Realty Investment Corp.’s 1.71 percent bonds due May 2011 instead of similar-maturity government debt averaged 0.7 percentage point yesterday, according to Japan Securities Dealers Association prices. It was as high as 2.11 percentage points in April 2009, the prices show.
--Editors: Tom Kohn, Andreea Papuc
To contact the reporters on this story: Yusuke Miyazawa in Tokyo at ymiyazawa3@bloomberg.net.
To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net.
From Bloomberg Businessweek published on August 23, 2010, 6:07 AM EDT
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