Chasing yield, investors favor credit again in 2013
NEW YORK (Reuters) - The desperate hunt for yield will continue in 2013, with investor money continuing to flow into high yield "junk" bonds, corporate debt and mortgage securities as it has this year, albeit with lowered expectations on returns.
According to a dozen money managers at the Reuters Global Investment Outlook 2013 Summit, the Federal Reserve's commitment to hold rates near zero until at least mid-2015 provides ample buying support for corporate credits.
This year, junk bonds and corporate debt markets have seen strong demand as the ferocious hunt for yield shows no signs of slowing with the JPMorgan Global HY index's year-to-date return up 14.22 percent and the JPMorgan IG index return up 9.8 percent.
Returns from investments in those securities are now coming down significantly, forcing some money managers to get out of their comfort zones and take on much more risk than they would otherwise.
"The economy still show signs of slowing. Europe's problems seem intractable," said Bonnie Baha, senior portfolio manager of DoubleLine Capital. "Swinging for the fences strikes me almost as foolhardy at this point in the game."
But it doesn't look like the game is about to end.
So far this year, bond funds, including ETFs, have taken in over $283 billion, according to Lipper data. In comparison, mutual fund-only outflows from equities is $62 billion, though an improvement over last year's $94 billion outflow.
Steven Einhorn, vice chairman of Omega Advisors, a $7 billion hedge fund founded by industry veteran Leon Cooperman, said the party in bonds will end "when investors begin losing money. You will then see these flows reverse. I don't think it is imminent because of monetary policy at around zero."
JUICE LEFT IN 'JUNK'
In September, both the European and U.S. central banks unveiled new bond buying programs. The massive monetary stimulus plans, which include very low short-term interest rates, have depressed yields on U.S. government debt to near record lows.
"There is such a lack of risk in the financial system right now," said David Schawel, a fixed income portfolio manager and writer for Economic Musings. "Are rates really going to spike up 4.0 or 5.0 percent overnight?"
Junk bonds yielding in the high-single digits still provide an attractive opportunity with defaults on the decline.
"In fixed income, we are virtually all in high-yield," said Margaret Patel, managing director at Wells Capital Management. "It still has the best risk reward" compared to Treasuries and investment-grade bonds, she said. "It is hard for me to see a big back-up in any fixed income investment, so why not get the extra yield?"
But not every investor is ready to jump into the deep and murkier end of the credit pool yet.
DoubleLine, the $50 billion bond firm founded by Jeffrey Gundlach, has favored residential non-agency, mortgage-backed securities (RMBS) through 2012, said Baha.
Now, the firm is looking at commercial mortgage-backed securities (CMBS) to help raise returns in 2013.
"The talk of CMBS has been floating around the office," Baha said, noting that while there is still an opportunity to make money in RMBS, the "more obvious trades have been completed."
DoubleLine recently added to CMBS portfolio exposure in both its DoubleLine Total Return Bond (DBLTX.O) and DoubleLine Core Fixed Income Fund(DBLFX.O). CMBS exposure in the Core Fixed Income Fund portfolio is now approximately 7.0 percent.
This year through October, mortgage-focused hedge funds have gained 13.3 percent, according hedge fund tracking firm eVestment|HFN. Credit-focused hedge funds in general have performed well, gaining more than 10 percent through October.
Most hedge funds, which are trailing the broader stock market, rose only 5.0 percent on average over that period.
Money managers speaking at the Global Investment Summit said there is no doubt the residential mortgage securities trade has been one of the hottest of 2012, but with yields in those securities falling investors are rotating into bonds backed by commercial real estate instead.
"Non-agency mortgages have suddenly become this hot thing; subprime is trading inside of 5.0 percent yields," said fixed income trader Schawel. "CMBS is more esoteric and harder for the average investor to understand, so there is more opportunities in a segment like that."
CMBS, STUCTURED CREDIT TOP BETS
Jeff Kronthal, who was the head of Global Credit, Real Estate and Structured Products at Merrill Lynch and now runs hedge fund KLS Diversified Asset Management, said he likes new issue CMBS, even though the market has been scared about the size of retail exposure in some of the deals.
"It's one of our biggest positions," he said, adding that with careful credit work and looking hard at the collateral, CMBS is an appealing investment. "Go to a mall - they're busy," he said.
Kronthal also said mortgage derivatives with a concern on "political risk" have become interesting.
KLS, the firm he co-founded in 2008, has also bought collateralized-loan obligations (CLO) in the 11 to 13 percent range. The issuance of new CLOs came to a halt in 2008 during the financial crisis, after reaching a peak of roughly $100 billion in 2007. But through 2012 CLO activity has slowly been ticking back up.
"We are long CLO in equity and some other parts of the capital structure. The new structures are strong."
"Loans look a lot riskier than they really are. They have collateral, they are secured and we don't think defaults will be that high," he added.
Hedge funds that focus on securitized credit rose 16.1 percent through October 31, eVestment|HFN data showed. So it is not surprising that hedge funds best-known for bets in the stock market are moving into the structured credit space to pump returns.
"We added structured credit expertise to the firm this year," said Einhorn of Omega Advisors. "That part of the fixed income market is attractive," with opportunities to achieve double-digit returns, he said.
Omega's structured credit team has invested in residential mortgage-backed securities and CLO equity this year, Einhorn said.
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