Bubble Fears Shape Search for Yield

Chidem Kurdas

Facing record low rates and high prices – two sides of the bond quandary – investors are looking for greater diversity in credit strategies. Their best bet may be managers who can move nimbly between different types of debt and go short in any market that looks wobbly.

Despite bubble fears, so far this year long/short credit is the best performing hedge fund strategy, up 8.64% according to Greenwich. But hedge fund firms such as BlueMountain – managing around $7 billion – that run diverse credit strategies face competition from a growing number of mutual funds.

Given that interest rates are well below historical norms, sooner or later a reversal to the historical mean is unavoidable, causing bond prices to fall. “Normalization will come,” says Stephen Smith, portfolio manager at Brandywine Global, a subsidiary of Legg Mason. This favors strategies that go short certain fixed income securities to gain from declining prices.

Brandywine, together with GAM International and PIMCO,  manages a wide-ranging bond fund that can hedge against rising rates. American Beacon Flexible Bond Fund  goes short or long credit, currencies and the yield curve. Mr. Smith said the fund is short French and German bonds, long Italian and Irish bonds.

This is a mutual fund with a 0.90 net expense ratio for institutional shares, which returned about 5.5% since inception a year ago.

Hedge funds that pursue similar strategies charge higher fees, of course. Do they provide better protection? Some argue that hedge funds can do better in this environment because of their greater flexibility. Even mutual funds with a broad focus may be unable to move into certain credit markets, in part because they have a more limited skill set.

Meanwhile, people are advised to reduce their holdings of junk bonds because that rally appears to be peaking.  On the other hand, there may also be a bubble in US Treasuries, no longer the place to go for security.

Other parts of the credit universe are more attractive. Guggenheim Partners says that while BB-rated bonds appear to be expensive, bank loans offer significant value.  Another source of higher return: mortgage securities and other structured debt.

 

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2 Responses to “Bubble Fears Shape Search for Yield”

  1. Are New KKR Funds Competitive? « HedgeFundSmarts Says:

    […] junk bonds is not exactly a novel investment program—we’re talking about a market that is possibly forming a bubble.  KKR Alternative High Yield looks too costly for what it […]

  2. Out of Bonds, Into Loans | HedgeFundSmarts Says:

    […] goes beyond the issue of pitifully low yields, which pushed investors to high-yield bonds, bringing down the rates on those […]

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