There’s a lot of money flowing into bank loans. As of May 17th, bank loan funds have had 48 consecutive weeks of inflows; year-to-date inflows have totaled a record US$24 billion. Compare that with year-to-date inflows of US$2.6 billion for high yield bonds. In fact, over the past 16 weeks, bank loan funds have averaged over US$800 million per week, and six of those weeks have represented the highest flows ever. A recent Wall Street Journal article covered the topic (paywall). Bank loans are a high yield asset class, which draws a natural comparison to high yield bonds. Consider this – despite the overwhelming positive demand for bank loans, year to date, high yield bonds have outperformed bank loans by over 2% (5.51% for the JP Morgan US High Yield Index vs. 3.26% JP Morgan Leveraged Loan Index). To me, this represents both caution and opportunity. Don’t assume that bank loans, as an asset class will outperform high yield bonds. That said, bank loans can still be a positive contributor if you understand what makes the asset class unique and if you understand what makes one issuer better than another. Read more
Posts from the ‘Fixed Income’ Category
Britain’s reigning monarch, Queen Elizabeth II, has graced the obverse (that’s coin-and-currency aficionado jargon for “front”) of the Canadian $20 banknote since 1954. Now, 59 years later, a Canadian is getting the opportunity to influence British money…well, monetary policy, at least.
On July 1, Mark Carney, a Canadian and the outgoing head of Canada’s central bank, will cross the pond to take over as the governor of the Bank of England. When he does so, Carney looks to be inheriting an economy that will likely be somewhat improved from the depths of its double-dip recession. The UK is, in fact, enjoying an upturn in activity. First-quarter GDP growth was a positive surprise, and the most recent purchasing manager index readings are suggesting that the recovery has stretched into the second quarter. Read more
Equities are at an all-time high and the demand for protection of downside risk has collapsed.
The Credit Suisse Fear Barometer (CSFB) is a measure of the protection that can be purchased through 3-month put options by selling 10% out-of-the-money (OTM) 3-month call options. For example, if put options and call options were equally priced for equivalent levels of money-ness, then the proceeds from selling a 10% OTM call could be used to purchase a 10% OTM put. As the demand for hedging downside risk increases, the cost of the puts will increase relative to the calls. When this happens, the proceeds from selling a 10% OTM call may only be able to purchase further OTM put options (e.g. 20% OTM).
What we have seen with the CSFB index for most of this year has been a relatively extreme demand for downside protection. As a case-in-point, the CSFB hit an all-time high of 35.24on March 26, 2013. What this meant is that – at that date – selling a 10% OTM would only be able to finance a put that was 35.24% below the current SPX level! In fact, during 2013, this index has averaged 31.05 when its long-term historical average has been 17.47.
But we have witnessed a notable break during the past two weeks. Read more
What’s one of the most noticeable consequences of the Fed’s third round of quantitative easing (i.e. QE3)? It’s the stark drop in fixed income volatility. Look at the chart below, which demonstrates this point for the investment grade credit market. The blue line is the rolling 21-day realized total-return volatility for a Barclays Global Investment Grade Credit Index. The red line is Thursday, September 13, 2012 – the day the Fed announced QE3. As the blue line crosses the red one, you can see marked drops in the level and range of volatility.
Oh dear. Reinhart and Rogoff may wish to avoid ever holidaying in Greece, Portugal, or Spain. Their seminal (and now-disproved) paper – arguing that once a country’s public debt was over 90% of their GDP, there is a strong negative relationship with the country’s economic growth – probably took up a fair amount of the Troika’s discussion time when it was deciding on the measures the peripheral countries needed to take if aid were to come their way.
Of course, Reinhart and Rogoff were not the only ones to argue that high government debt is bad for growth. Over the years, several economists have pointed out that government borrowing can crowd out private investment, and that reducing government borrowing can allow growth to resume. Read more
From the desk of risk:
The trader sums his gains. The investor compounds her returns.
When I was a kid, we used to have bike races through the neighborhood. One particular race on a summer evening featured a 1.5 mile route, a fit 12-year-old on a dirt bike, and a slightly pudgy 10-year-old on a ten-speed. Of course, the ten-speed was a much bigger bike so it was going to be an interesting race. Those not racing would follow along on their bikes or wait at various points along the route. A few bets were made (mostly trading cards) and the race was on.
The race began exactly as would be expected – the older boy on the smaller dirt bike jumped out to an enormous lead. At one point, the distance between the two riders was somewhere between two to three hundred yards. But . . . slightly past the halfway point, the younger boy on the ten-speed pulled ahead. In the end, it wasn’t even close.
Why did the younger boy win? Read more
Last week, I introduced the idea of ten concrete concepts that our high yield research team uses to help summarize the many interacting factors and variables that make high yield a unique and challenging asset class. In my previous blog post, I covered the first five: cash flow, capital, cushion, cyclicality, and competition. To finish up this thought, here are the last five:
- Cost Structure – A company can’t provide products and services to customers without incurring some costs. Within a particular sector, many companies face similar cost pressures, but not always. For instance, there is a currently great disparity between the cost of natural gas in Europe (high prices) and in the United States (low). This has created a tremendous opportunity for companies in the chemical sector that use natural gas as an input to their production process.
- Read more