Analysis: Wealthy investors looking to snap-up risky debt

LONDON Wed Feb 9, 2011 8:55am EST

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LONDON (Reuters) - Has the time come to buy some of the world's most unloved investments, such as Greek bonds, and stick them in the bottom drawer?

Hedge funds and wealthy private investors increasingly appear to be saying yes, attracted by yields that blow away what can be found on many other assets.

It is not for everyone -- indeed, many mainstream investment firms cannot follow the route -- but the idea is that a lot of higher yielding debt with two to five years to run is promising significant return with diminishing risks.

Longer-term bonds or, in some cases, those with better credit, have been losing favor because of both low yields and the general global risk rally that has taken hold with economic recovery.

But at the riskier end there are signs of life.

A good example of the phenomenon is Barclays Wealth, which has recently encouraged its well-heeled clients to consider buying two-year Greek government bonds.

Battered by the debt crisis, such paper is currently yielding more than 11 percent and, unlike longer-term paper, is all but guaranteed by the European Union and the International Monetary Fund bailout.

So Barclays considers the default or restructuring risk for short-term paper to be slight.

"You have a backstop of EU money being able to come in case people are struggling," said Michael Dicks, the wealth manager's chief economist.

He added that IMF and EU monitoring should also ensure that Greece sticks with its budget repair plans.

The Greek paper is nonetheless likely to be volatile, so the key is to buy it and hold it to maturity, locking in what amounts to 11 percent a year plus the return of capital.

"What we are trying to do is provide a more attractive (investment) than cash. They are cash-like in the sense of short maturities," Dicks said.

ROLLING ALONG

A similar approach is being taken by State Street Global Advisors, but with an eye on high-yield corporate credit rather than troubled euro zone debt.

Yields on high-yield, or junk, bonds differ widely depending on the issuer, but a range of 6.0 to 6.5 percent should be attainable on, say, five-year dollar bonds.

Richard Lacaille, SSgA's global chief investment officer, told a Reuters briefing recently that his firm and a number of its clients were looking at buy-and-hold positioning.

"We are talking about a roll down strategy with maturities less than five years," he said.

Roll down essentially means buying a bond and keeping it as it heads toward maturity, perhaps only selling it toward the end if the price return by dumping on the secondary market would bring in the same overall return.

The risk, of course, is default, which is why the yield is so high in the first place.

But with signs of the global economy growing at a near-normal pace, default rate expectations are low.

Rating agency Moody's forecasting model, for example, predicts that the global corporate speculative-grade default rate will decline to just 1.5 percent by January next year.

Investor interest in high-yield bonds is generally running quite high, although most of the allocation is the more typical buy-and-expect-to-sell strategy .

Reuters global asset allocation poll for January showed overall bond holdings at their lowest level since last February, but with interest in high-yield debt having grown steadily since August.

High-yield bonds now account for 12.9 percent of bond portfolios held by poll respondents, representing many of the largest investors in the world, well above the 9.8 percent average for the past year.

ONLY FOR SOME

Buy and hold strategies such as these are not for everyone. Some funds, for example, are prohibited by their mandates from holding such high-risk debt.

More of a barrier yet is the need to "mark to market," the requirement than many institutions report the market value of their holdings at various times.

Buying a volatile bond such as Greece's two-year, for example, might mean that a fund would have to write up a paper loss on capital even if the end result would amount to an 11 percent a year investment.

"There are very few places in the world where you can just buy and hold and forget," said Andrew Clare, professor of asset management at Cass Business School in London

That said, strategists with RBC Capital Markets told reporters at a briefing this week that they were hearing about a number of groups getting in on the short-term buy and hold strategy.

SSgA's Lacaille also said his clients were showing increasing interest in holding high-yield corporates down the curve.

Investors who are used to taking more risk -- such as hedge funds -- or have fewer restrictions on what they do -- such as wealthy individuals -- were the most likely.

Emerging market funds, in the meantime, were reported to be taking an interest in Greece.

The search for yield, after all, has been the main theme of investors ever since central banks began slashing official rates to combat the financial crisis.

(Editing by Patrick Graham)

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