* Yield hunt sees investors chasing riskier bonds
* Hedge funds among major buyers of Cyprus, Greece
* Longer-term investors join queue for scarce yield
* BIS has warned of "worrying" signs in credit growth
By Nigel Stephenson
LONDON, July 3 The hunt for yield in an era of
diminishing interest rates has lured investors into ever riskier
regions of the bond market, prompting some to ask: who is buying
this stuff and are they suffering short-term memory loss?
In June, euro zone member Cyprus returned to the market just
a year after international lenders bailed it out and the
government forced bank depositors to forfeit uninsured savings.
Ecuador, which defaulted in 2008 and in 2000, raised $2
billion with a bond, and Kenya, troubled by attacks by
Somalia-linked Islamist militants, had investors offer it more
than four times the $2 billion it borrowed via a debut Eurobond.
In April, twice bailed-out Greece, whose 2012 debt
"restructuring" was classed as a default by credit rating
agencies, borrowed 3 billion euros in five-year bonds. Investors
expressed interest in buying 20 billion euros worth.
All four issuers have speculative-grade credit ratings - a
warning flag that they could have trouble paying as promised.
Typically such borrowers offer relatively high interest
rates to compensate for the inherent credit risk. But in a world
of near zero interest rates and sub-3 percent yields on U.S.
Treasury bonds or German Bunds, the rates being demanded for
taking on significant additional payment risk have shrunk.
Kenya's 10-year bond yielded 6.875 percent at launch and
Ecuador's 7.95 percent. The Cyprus bond offered 4.85 percent.
The German or U.S. governments used to pay such rates for
10-year domestic currency debt prior to 2000.
So who's suddenly willing to throw caution to the wind?
The Bank for International Settlements, the global forum for
central banks, warned this week that a pre-crisis credit
environment was re-emerging and that pension funds and other
long-term investors are taking ever bigger risks.
"The one thing that is different between now and 2006/07 is
that the protagonists... are no longer... the banks. Long-term
investors are also joining in," chief economist Hyung Song Shin
But how do they get sucked into lending to serial defaulters
and near bankrupt nations?
Some simply make a credit assessment and reckon this time
will be different. Others assume they will not hold the
securities long enough to find out.
But if a high percentage of initial bidders sells out after
a few weeks or months and when arrangers' commitment to support
the market for the bonds expires, someone must be picking up the
bonds, even if at a lower price, and becoming a creditor.
Often the short-term speculative players have ready-made
buyers in index-tracking high-yield or emerging market bond
funds whose coffers have been swollen in recent years by
relatively conservative investors such as pension funds
desperate for higher returns and widely diversified holdings.
In some cases the former simply "flip" the debt on to the
latter group, who buy it once the banks arranging the sale
indicate they have sufficient bidders to qualify the bond for
global investment indices.
Market timing is then the name of the game rather than the
assessment of long-term credit risk.
"When you play chicken, who's going to go first?", said
Guido Barthels, chief investment officer at Luxembourg-based
fund manager Ethenea, which bought the Cypriot and Greek bonds.
"There's hardly anyone out there who's willing to hold this
until it matures, perhaps only the local banks," he said of the
Cyprus bond, which has since fallen in price to
yield 4.97 percent.
"It's a question of who gets out first."
While funds that buy and sell quickly in search of returns
may inflate the size of the deal - itself a criterion for
drawing in more passive funds - they do increasingly find
themselves in the queue with more traditional buy-and-hold
"People are getting forced into taking more risk in order to
make what were previously easy attainable returns," said Peter
Doherty, Chief Investment Officer of Tideway Investment
"It's amazing how short people's memories are."
In the case of Cyprus, hedge funds bought 27 percent of the
issue, other fund managers took 51 percent and banks 22 percent.
The picture was similar for the Greek bond.
While many pension or insurance funds would not be permitted
to buy debt below a stated credit rating, they will have
proportions of their portfolios - often labelled as a
diverisfying 'alternative' investment - that are able to buy
into, for example, dedicated emerging market funds that measure
themselves against catchall indices or all-inclusive benchmarks.
JPMorgan, which runs one of the main emerging bond indexes,
said emerging market dollar-denominated fixed income funds had
seen inflows of $10.9 billion of new money this year and so have
funds they need to deploy in buying new bonds.
The existence of the indices is a big incentive to buy and
accounts for many of the long-term holders of such bonds.
"Plenty of investors do that. They hope it gets the
additional index inclusion boost," said David Spegel, global
head of emerging markets sovereign and credit research at BNP
Paribas, adding that the bank syndicate desks that gauge demand
for a bond and are involved in its sale and distribution, would
ensure a bond was not only sold to "flippers".
Even investors with a generally long-term outlook may find
the prospect of a quick profit irresistible.
"Even if they are basically long-term investors, they can
make 2.5 points within a week by flipping. You have to ask
yourself what part of the life of this bond will ever make you a
return like that," said Jeremy Brewin, head of emerging debt at
ING Investment Management
He bought both Kenya and Ecuador, saying of the latter:
"It's as good if not better than many Central European or Latin
The Kenyan and Ecuadorean bonds both qualified for inclusion
in the benchmark JPMorgan bond indices. Kenya's $2 billion
maiden issue of five- and 10-year bonds was overwhelmingly
bought by fund managers, with insurance and pension funds buying
6 and 4 percent of the two issues respectively.
"IN THE INDEX"
"It's in the index, everybody has to have Africa," said
Stephen Bailey-Smith, head of Africa research at Standard Bank.
Does that mean issuers of bonds likely to end up in the
benchmark indexes end up borrowing more than is good for them?
"You sometimes get people coming along saying they want to
borrow 300 million and they're told the order book is five times
so they go, 'I might as well borrow a billion then'. You can't
blame them for doing that," said Colm McDonagh, head of emerging
market debt at Insight Investment, which is part of BNY Mellon.
"It's more prevalent in the corporate world but to a certain
extent you can see that happening in the sovereign world."
But if things do go wrong and buyers of riskier bonds want
out, there are specialists waiting in the wings.
"If you look over the last 30 years, we have had Latin
American debt crises, you get periodic events where things go
badly wrong," said Doherty at Tideway Investments. "But in
general there is a pretty well functioning stressed and
distressed (debt) market."
(Reporting by Marius Zaharia, Sujata Rao, Carolyn Cohn, Chris
Vellacott and Nigel Stephenson in London and Daniel Bases in New
York; editing by Janet McBride)