The stretch for yield looks set to continue now that fears over an imminent Federal Reserve (Fed) rate hike have diminished, though investors may want to think twice before overreaching for yield.
Last week, minutes from the Federal Reserve’s Open Market Committee’s (FOMC) March meeting confirmed that the FOMC did not intend to convey a more hawkish posture following its March meeting and the U.S. central bank is in no rush to raise interest rates. Instead, concerns about persistently low inflation suggest that the Fed intends to keep rates “low for long.”
Stubbornly low yields have made income tough to come by in recent years, and they have sent investors searching for yield and income wherever they can find it.
As I write in my new weekly commentary, the prospect of a prolonged period of low rates is encouraging investors to continue to stretch for yield by entering ever more speculative fixed income asset classes in which the risks may not be worth the higher yields, such as Greek bonds.
Greece’s recent bond sale, for instance, was 8x oversubscribed, meaning the amount of purchase requests exceeded the amount of bonds available. Foreign investors bought more than 90% of the issue, which yielded less than 5%, the lowest yield since before the advent of the European crisis.
In another sign of investor hunger for yield, leveraged loan sales in March hit more than $11 billion. While this isn’t particularly high by the standards of the bond market, it was the strongest showing since May of 2007.
Investors in need of yield should consider the risks, not just the potential return. While there are no absolute bargains in fixed income, there are at least a few segments of the bond market that offer relative value.
I continue to like U.S. high yield and tax-exempt bonds. These two asset classes offer a reasonable yield, without undue volatility. In addition, year-to-date, both have outperformed a broader fixed income benchmark, with municipals being one of the best performers so far in 2014. You can read more about why I like these fixed income sectors in my latest Investment Directions monthly market commentary.
Sources: Bloomberg, BlackRock Research
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets.