The market for negative-yielding bonds is now worth around $6 trillion, and has doubled in just over a month, showing just how worried how investors across the globe are about the state of the world’s economy.
Liquidity in the biggest individual high-yield fixed income funds varies significantly from one portfolio to the next, according to an analysis by Fitch Ratings.
Great post by Josh Brown at The Reformed Broker about how listening to the market pundits can lead investors to abandon their investment plans to their detriment.
Let me wrap this up: 401(k) accounts are sacred, but they are not magic. They require a thoughtful person making decisions and behaving logically in order to work. The 401(k) users who have persevered through the large drawdowns of 15 and 7 years ago, while continuing to plug away with fresh contributions, are doing better than ever.
Source: The Farce Awakens
It’s important to remember there are two reasons for diversification. The first is it reduces risk, and the second is it exposes you to whichever asset class is doing well each year. Since we don’t know which asset class will be the best performing ahead of time, think of diversifying across asset classes as fielding a baseball team, wherever the ball is hit to on the field there is someone positioned there to make a catch.
This year the rebound in real estate from the 2007-2009 crisis made REITs the top performing asset, while emerging markets added to their run as the bottom performer. (Commodities were down so much they didn’t even make it onto the chart)
Liquidity is a coward – It’s never there when you want it.
Recently I was listening to an interview with Jeff Gundlach, the CEO and CIO of Doubleline Capital, where he was talking about the liquidity of commercial mortgage backed securities (a type of bond that is backed by mortgages on commercial buildings) and he used that phrase to describe the market in those securities. Until you have actually been in a position that you can’t get out of at a reasonable price you would never understand how true that statement is. Unfortunately in the last week, many high yield bond investors and managers at Third Avenue Focused Credit Fund are finding out how price and liquidity can disappear just when you need it most. (Third Avenue Blocks Redemptions From Credit Fund Amid Losses)
I love clichés. The thing about clichés is that they wouldn’t be around and so heavily used if they weren’t true. In this case, there is a hard lesson to learn. One that can go without notice until you are right smack in the middle of it and wishing there was a way out.
To be sure, bonds (fixed-income products) play an important role in any investment strategy, providing specific characteristics, such as predictable coupon/interest payments (usually fixed), fixed maturities and return of principal. These factors, in combination, are essential for effective financial planning and overall asset allocation. Additionally, and perhaps most importantly, bonds provide a necessary counterbalance, acting as a low-correlation asset to the higher-volatility equity portion of a portfolio.
With today’s ultra-low yields, it’s safe to say that every income-producing rock has already been turned over. If there were a foolproof way to generate extra income without additional risk, investors would already be all over it, pushing up the security’s price and pushing its yield down. Instead, higher yields are invariably a signal that a security type entails more risk than its lower-yielding counterparts.
Why would an investor pay a central bank to hold their money? There are only two reasons I can think of. One, you are speculating that another investor will come along and pay a higher price to buy the bonds from you (current European Union Central Bank scenario) or two, you are seeking safety in a very unstable environment where your only concern is the return of your principal.
Today’s negative yields are the manifestation of central bank policy pushed to an extreme.
Germany sold two-year government debt at a record low yield of minus 0.38 per cent on Wednesday, in a move reflecting expectations of further monetary easing for the eurozone next month. The policy-sensitive two-year bond offers a coupon of zero,
At the 2015 CFA Institute Fixed Income Management Conference in Boston, I learned that almost every speaker is concerned about the liquidity of corporate bonds. Many pointed the finger at Dodd-Frank and Basel III, which require greater amounts of high-quality capital. This means that investment banks, long-time facilitators of corporate bond-market making, are doing very little of it as they are reluctant to hold the inventory. This flies in the face of evidence that the bid-ask spread is narrowing. Speakers pointed out that much of the liquidity is being provided by hedge funds running algorithms designed to make money based on mispricing. But what happens when the conditions in which algos normally trade are violated? Most of the speakers think there would be no liquidity. Ouch!
When rates start to rise what will happen to the bond mutual funds? Could the lack of liquidity in bond markets and a market structure of requiring a broker to execute trades lead to a liquidity crisis?
There is a difference between owning individual bonds and owning a bond mutual fund.
When it comes time to sell, it can
be hard to find a buyer, and vice versa. PIMCOs
chief investment officer for U.S. core strategies, Scott
Mather, has compared the bond market to that for real estate. Few people list their houses on a website and expect to find a buyer. Instead, they pay an agent, who may
know a young couple interested in a fixer-upper next to the
railroad tracks. Both bonds and houses are far from
homogeneous. Real estate brokers have maintained their grip on
their market, despite consumers buying everything from
groceries to puppies online. “You can’t force every
house to be the same or force every issuer to issue the same
bond,” says Mather. Since the financial crisis, though,
players in the bond market have become more receptive to
technology and new solutions. They’ve had to as banks have
been regulated out of playing their traditional role as market
makers and, in a pinch, providers of liquidity.