In this months Fixed Income Focus - Yield Grab, Ben Bennett discusses some of the issues investors face as increasing amounts flow into Corporate Bonds, as investors attempt to increase the yield they can get from their investments.
Despite this uncertainty money keeps coming into fixed income funds, reacting to the low interest rate environment by looking for yield. Is this the result of successful non-standard monetary policy, or another bubble waiting to burst?
By cutting interest rates to virtually zero and then buying significant amounts of government debt, central governments have tried to discourage saving and prompt investment back into the economy via corporate bonds and equity markets. If the strong retail flows into corporate bond funds, particularly high-yield funds, are anything to go by, this has been achieved. Indeed, many corporate bond markets now trade with a yield at an all-time low, and even the relative yield (i.e. the extra yield over and above the ‘risk free' rate) is below historical averages in many cases. Companies that have benefited from this dynamic can therefore borrow money at very low levels and use the proceeds to buy equipment and hire people. The theory is that such activity will take economies out of their malaise and ultimately reward investors' risk taking.
There are two significant problems with this theory. The first is that low borrowing costs have yet to trigger a satisfactory demand for credit. Bank surveys suggest that credit conditions have been loosening, but that loan demand remains very low. Perhaps this is simply a chicken-and-egg type situation, and demand will slowly pick up as time progresses. Maybe central banks just need to cut interest rates again or buy some more government debt, and credit demand will gradually follow. I have my doubts. I think the reluctance to take on more debt is a natural consequence of the credit boom that brought us to this difficult situation in the first place. Consumers, banks and governments are already laden with significant amounts of debt. Many are actively trying to pay down their debt rather than take on more. Those that don't need to reduce their debt are reluctant to invest in assets whose value remains boosted by the debt of others (the UK property market springs to mind).
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