Why Investors Keep Buying Expensive Bonds

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road sign to bond market
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By Leslie Shaffer

It's pretty clear bonds are a bad job, with returns relatively meager and prices likely to fall ahead, but yield-seeking investors keep pushing money their way. "People have been buying bonds for some years and going further out the risk spectrum to get yield as Treasury yields fall," said Mark Matthews, head of research for Asia at Julius Baer. Bond yields move inversely to their prices. "There's not a lot of value left in fixed income in general, not just the high yield," he said.

"With the Federal Reserve tapering [its asset purchases] and looking to raise rates next year, the price appreciation we've seen generally over the last five years [will reverse] and prices will fall as yields head up," Matthews said.

That hasn't stopped investors from chasing bonds' payouts. So far this year, $56.69 billion has flowed into bond funds, outpacing the $44.06 billion heading into equities, according to data from Jefferies.

All those funds chasing what appear to be ever-smaller yields have kept bonds expensive and sometimes crowded.

"Investment grade credit is trading rich and looks increasingly vulnerable to rising rates," Morgan Stanley (MS) said in a note last week. "Upside appears very limited in high yield, and a negative shock [emerging market turmoil, weaker China or domestic growth etc.] is possible."

Others are concerned about the move further out the yield spectrum.

"The yields that you're getting over government bonds have reduced dramatically. We're not at record-tight levels but we're not that far away," Steve Goldman, managing director at Kapstream Capital, a fixed income fund manager with $7 billion under management, told CNBC last week.

"What it's meant that investors are moving toward greater and greater risk in order to pick up slightly higher yields. And you've got to be careful because the quality of the issuance in that high yield or junk space is going down," he added.

Just how much risk are investors chasing? The International Finance Corp., a World Bank unit, is getting ready to offer local-currency bonds in Rwanda next month. The Rwanda offering will likely be well received, if the reception of the IFC's first offering under its Pan-Africa note program is anything to go by. That issue -- of 150 million Zambian kwacha ($24 million) notes in September -- was 4.8 times oversubscribed, according to a Bloomberg report.

Rwanda raised $400 million in a 10-year Eurobond bond offering last year, with the yield on the notes due 2023 falling to around 6.7 percent this year. By way of comparison, India's 10-year government bonds due in 2023 are yielding around 8.9 percent.

Even the seemingly "safe" U.S. Treasury segment is seeing some risk chasing. Barclays is advising seeking out "off-the-run" Treasurys, or bonds and notes issued before the most recent paper, to squeeze out around 30-56 basis points of extra yield -- even though the off-the-run bonds are much less liquid.

"We are comfortable taking some additional liquidity risk to pick up spread," Barclays said in a note last week.

To be sure, not many expect a bond crackup anytime soon.

"A downturn in the current credit cycle seems unlikely and the coupon income of high yield is hard to find elsewhere," the Morgan Stanley note said.

Others point to data from Moody's indicating corporate issuers don't seem to be running into any walls just yet.

"There has not been an increase in the default rate," Julius Baer's Matthews noted. "Cash levels at corporate America are at an all-time high," he said. "The credit metrics are still very robust in the high-yield market. That's why people are still very happy to stay there, even if you don't get paid very much."

Richard Harris, CEO at Port Shelter Investment Management agrees that problems at the corporate end don't appear likely, but he's a bit more cautious on sovereign bonds.

'Toughen Up or Die'

"The last few years, corporates have had to toughen up or die," he said. "When interest rates go up, and they will eventually, it's a lot less likely to impact the corporate sector than it is the government sector," he said.

As the eurozone debt crisis has settled down, investors have plowed into peripheral Europe's debt, but "it doesn't mean to say dangers are any less," Harris said, noting the size of interest payments due from the periphery this year alone. The PIIGS, or Portugal, Ireland, Italy, Greece and Spain, will pay some 130 billion euros in interest this year alone, according to calculations from the Financial Times.

Yield chasing has led to anomalies in European bonds, such as still-worrisome Spain recently selling five-year government bonds at nearly the same yield as their U.S. Treasury equivalent. The yield for five-year Spanish debt was around 1.68 percent as of Wednesday morning; U.S. Treasurys were around 1.68 percent.

This month, Greece also issued its first long-term bond in four years, with the five-year security attracting 20 billion euros worth of bids. Greece sold around 3 billion euros worth of debt at an around 4.95 percent yield.

"We're likely to see people focus on the growth aspects, rather than the debt aspects," he said, but added "it's still a fragile situation. The overall economy [of Europe] looks good, but that because Germany looks extremely good."


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24 Comments

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jenniferetmfs

All investment types come with some inherent risks, so each investor needs to know beforehand about them. That takes research and self-education. It's not easy and it can be confusing, but it can be done. For example, go to http://www.mutualfundstore.com/bonds to learn about the various kinds of bonds you might want to pursue. Also learn about fees and things associated with them. It's a lot to take in, but with a bit of patience and dedication, you can make sense of it.

May 16 2014 at 1:03 AM Report abuse rate up rate down Reply
John Roberson

well the ones who can not understand the move into bonds are obviously not the buyers. Perhaps they want the bond market to fall, so perhaps these people are selling bonds or are taking a short position if one can. It is like if one has enough influence in the decision making process, like many people have in Washington, find out where their associates are placing their money. If I wanted to know for example where the government's position was on a pipeline, I would examine where someone invested his money, and who had influence on someone who could make that decision.

April 24 2014 at 1:27 AM Report abuse rate up rate down Reply
thefacts22

USA is in real trouble.I am afraid the dollar will crash,do not trust this regime and is very difficult to transport gold or silver.the only solution is electing someone that has some financial know how and some brains..

April 23 2014 at 8:00 PM Report abuse rate up rate down Reply
kitharris1

so the question is where should we park our money?

April 23 2014 at 1:11 PM Report abuse +2 rate up rate down Reply
2 replies to kitharris1's comment
alfredschrader

Interestingly, the gov can default on bonds but FDIC deposits are insured to $250,000.00 per account.
I would avoid the Swiss banks like a disease. Why ? They'll keep your money. Say what ?!!!
Yep. They did it to me.
During the war my grandparents put money in the Swiss banks to protect it. They passed on in the 1990s
When I contacted the Swiss banks to recover these funds, they told me to get lost and even tried to chage me $100.00 just to discuss it with me. If you lose your account number, kiss your money goodbye. The Swiss banks have no intention of ever giving it back to you and there is nothing you can do when they grab it.

April 23 2014 at 3:12 PM Report abuse +2 rate up rate down Reply
2 replies to alfredschrader's comment
Silent Hill

There are ways to get around the FDIC insurance limits of 250k. The website gives full details. The risk with bonds is not really about losing your principle. Its more about the money being devaluated through inflation. If inflation is higher than the percent in interest made, you are getting poorer. youyr money buys less.

It's worth mentioning that not one penny of FDIC insured funds has ever been lost. The US government has never defaulted on it's debt either though. If there was a massive enough bank failure, would they be able to cover? Who knows?

I think if the government had to print every single dollar to pay out on bonds and FDIC insured funds they would do it. Not doing it would be too catastrophic to think about.

I like buying and holding 5 year TIPS to maturity. They are expensive, but have an inflation hedge. If you believe mass inflation is coming like I do, then that is the way to go.The real risk in bonds is that the interest won't keep up with inflation

April 23 2014 at 4:08 PM Report abuse +1 rate up rate down
thefacts22

Swiss Banks are very secure,if you NEVER lose your account number

April 23 2014 at 8:03 PM Report abuse -1 rate up rate down
thefacts22

We are in the hands of a brain dead Government

April 23 2014 at 8:02 PM Report abuse -1 rate up rate down Reply
alfredschrader

Back in the day the solid play was to buy gov bonds about to mature in a couple of years.
For example a $1,000.00 bond selling at $960 and yielding 2%.
There was no commission at maturity saving the selling expense and gov bonds were secure then.

April 23 2014 at 11:35 AM Report abuse rate up rate down Reply
1 reply to alfredschrader's comment
thefacts22

The good old days are no more

April 23 2014 at 8:05 PM Report abuse +1 rate up rate down Reply
bchrist751

Been hearing these same scare stories for years and each year they are wrong....

April 23 2014 at 11:11 AM Report abuse -1 rate up rate down Reply
1 reply to bchrist751's comment
thefacts22

USA has been working in the red over 5 YEARS,we are in an unsustainable path

April 23 2014 at 8:07 PM Report abuse -1 rate up rate down Reply
2 replies to thefacts22's comment
clark8642

In the red for five years? More like 13. Ever since Congress passed the temporary tax cuts in 2001 spending has exceeded revenue. I gather you are only worried about the last five years.

April 23 2014 at 10:46 PM Report abuse +1 rate up rate down
clark8642

Dopey. If your point is that President Obama was wrong to sign the American Taxpayer Relief Act of 2012, then I agree with you. And yes the debt has been around for more than 13 years but in 2001 we were actually in a surplus mode and worried about eliminating the debt by 2011 before the 'temporary' tax cut fiasco.

April 24 2014 at 6:21 AM Report abuse +1 rate up rate down
Silent Hill

Most posters here are content picking a political side and blaming the other. They condition voters to react that way.

This is an economic problem not a political one. The country is (and was) spending itself broke. Energy prices are too high. The cost of living is too high. No one has the discretionary money to spend anymore. This is strangling the economy. If the economy doesn't thrive = there will be no meaningful job creation. Hence the viscious cycle.

April 23 2014 at 9:24 AM Report abuse +5 rate up rate down Reply
2 replies to Silent Hill's comment
bchrist751

The problem is that politicians cause economic problems.....

April 23 2014 at 11:12 AM Report abuse +1 rate up rate down Reply
thefacts22

I think our economic problems are "created" by political crooks...Is time to change

April 23 2014 at 8:11 PM Report abuse +1 rate up rate down Reply
Silent Hill

People are right to be concerned. We are on the brink of great depression type poverty. Inflation is going to be the final nail in the coffin. Safe bonds souns great, "If" the US has the ability to pay them off. Printing more money will just devalue the currency.

Foriegn money will run out of the country. True, bonds are safer than being in the stock market if it gets halved. In truth, the government is not likely to default. They 'll just print more monopoly money and pay everyone off. The old paradigm will go out the window if a loaf of bread cost $20. Most people won't have enough monopoly money to buy the bread.

The devalued money will not hold up to inflation. TIPS are probably the best bet (in a rigged game) because they have inflation protection.

April 23 2014 at 9:14 AM Report abuse +4 rate up rate down Reply
1 reply to Silent Hill's comment
thefacts22

I agree with you 100%,if we keep spending dollars like drunken sailors,we will collapse

April 23 2014 at 8:14 PM Report abuse -1 rate up rate down Reply
teaparty2implode

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April 23 2014 at 8:37 AM Report abuse -8 rate up rate down Reply
1 reply to teaparty2implode's comment
Silent Hill

Here's the problem with what you are saying. If you just demonize everyone who happens to disagree with you, Then you become 100% right and everyone elses opinion becomes moot. because their concerns are just imagined.

While I don't disagree that money power helps fuel the current paradigm on both sides. The problem is that your side is no more 100% right than their is. If you never have to look in the mirror then you are absolved.

The problems don't get solved either.If you don't see that there are rel economic problems afoot then you can't solve them.

April 23 2014 at 9:38 AM Report abuse +4 rate up rate down Reply
obielies

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April 23 2014 at 7:21 AM Report abuse +2 rate up rate down Reply
2 replies to obielies's comment
teaparty2implode

Billy Bob,....you need to stop drinking the tea party's tea it's spiked with nuts and froot loops. The tea party wants to go forward ? That's a lie, they want to repeal the 21st century.

April 23 2014 at 8:34 AM Report abuse -5 rate up rate down Reply
teaparty2implode

Billy Bob is Rush Limppig's favorite low information voter.

April 23 2014 at 8:35 AM Report abuse -3 rate up rate down Reply