Dow Jones Reprints: This copy is for your personal, non-commerical use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool on any article or visit www.djreprints.com
GLOBAL BOND YIELDS PLUNGED to new depths as markets have all but assumed the Federal Reserve will join in the central-bank bond-buying binge.
Yields have fallen in the leading government bond markets to levels that have even ardent bond bulls wincing. In the U.S. Treasury market, the two-year note yield melts a little more each day, touching 0.379% Wednesday. The five-year note also set a record low yield of 1.122%.
The collapse in government bond yields continued elsewhere around the world. In Japan, the 10-year government bond hit a seven-year low of 0.84% a day after the Bank of Japan announced its plan to purchase up to ¥5 trillion ($60 billion) of assets, mainly JGBs. In Germany, the 10-year bund hit 2.224% while the 10-year U.K. gilt fell to 2.889%. And back in the U.S. of A., the 10-year Treasury note closed at 2.392%, a new low for the rally that started at the beginning of April when the benchmark note traded at 4% amid confident forecasts of rising rates in response to a robust recovery.
It's turned out to be anything but that. The latest indication came from the ADP employment report, which showed private employers cut 39,000 jobs in September instead of adding 20,000 to their payrolls, according to the consensus forecast. And continued labor market weakness has Fed officials calling for further security purchases to boost the economy, as noted here previously ("Coming Full Circle on Monetary Policy," Oct. 6)
While expectations are for some form of so-called quantitative easing or large-scale asset purchases (QE or LSAP in the current jargon), other alternatives to the Fed targeting a set amount of purchases apparently is being considered. According to the Washington Post, the Fed is mulling various approaches, including setting a specific yield level for various Treasury maturities instead of targeting a certain quantity of securities purchases. If that idea sounds familiar, it was discussed here more than a week ago ("Is the Fed Mulling 'Qualitative Easing?'" Sept. 28)
The Fed could peg a yield for Treasury notes, just as it does for the overnight federal funds rate. That would force investors more than ever to move to other, riskier alternatives, which is basically the idea behind setting the overnight rate at zero and purchasing securities under QE or LSAP or whatever you want to call it.
Yet ironically the more yields fall, the more some veteran bond investors want to protect against an eventual rise in rates. Floating-rate assets, such as bank loans, were top picks of two such portfolio managers in separate conversations.
Jonathan Beinner, chief investment officer and co-head of global fixed-income at Goldman Sachs Asset Management, thinks corporate bank loans comprise one sector. Specifically, he's drawn to the senior tranches of collateralized loan obligations, one of the kinds of derivative structures that collapsed in the credit debacle in 2007-08.
But unlike other credit derivatives, Beinner says these have withstood the test of time. In contrast to CDOs backed by pools of rotten residential mortgages, the CLOs were made up from senior, secured debt that was issued by below-investment-grade companies. The formerly triple-A-rated top tranches of the CLOs have substantial credit protection, including significant subordination levels; that means cash flows accrue to these senior tranches. Even in the event of defaults, these structures would be in good shape, Beinner contends.
Neither do these floating-rate assets have interest-rate risk. The loans float at 300 basis points (three percentage points) above the London interbank offered rate, or Libor, which nets 3.25%. You'll never get rich on that, he admits, but consider that's 85 basis points more than the 10-year Treasury, with little credit risk and no interest rate risk. Just a back-up to a 3% yield would leave Treasury with zero total return over the next 12 months., however.
Similarly, Cliff Corso, president and chief investment officer of Cutwater Asset Management, also is drawn to top tranches of bank-loan structures. At a yield spread of 300 basis points over Libor, it compares well to the five-year Treasury with the added benefit of protection against rising rates.
There are various bank-loan mutual funds, including picks from fund-tracker Morningstar, including the Eaton Vane Floating Rate A (EVBLX) and Fidelity Floating Rate High Income (FFRHX.) Closed-end funds perhaps are better suited to the asset class given the limited liquidity of loans. (Closed-ends don't continuously redeem and issue shares, but have a set amount. Thus, they aren't subject to "runs" as mutual funds are in crisis periods.)
Two closed-end fixed-income funds that aren't pure loan funds but have significant allocations to the sector and sell at attractive valuations are Eaton Vance Short Duration Diversified Fund (EVG) and Franklin Limited Duration Income Fund (FTF.) They are roughly equally divided among bank loans, junk bonds and mortgage-backed securities, a brew that reduces volatility. The Eaton Vance fund yields 6.20% and trades at a 4.28% discount from net-asset value, according to www.cefconnect.com. The Franklin fund yields 7.43% and trades at a 3.48% discount. Both funds utilized a relatively modest level of leverage to boost returns—a profitable strategy while the Fed has short-term borrowing costs at near zero.
As yields on government debt plunge to levels once unimaginable in anticipation of central banks' purchases, investors are beating the bushes for safe returns. Solid, dividend-paying stocks no doubt are best for the long run. Those looking for a less-volatile alternative to either stocks or bonds over the near term could consider these funds.
The reality is that returns are apt to remain far lower than what investors are seeking for some time. Central banks are working to lower yields to spur spending and investing in riskier sectors. What the central banks are buying already has gone way up in price. Investors should look to buy what the Fed isn't.
Comments: e-mail: randall.forsyth@barrons.com
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
Yahoo! Buzz
MySpace
Digg
del.icio.us
NewsVine
StumbleUpon
Mixx
Caris says fewer makers of generic Lipitor means higher prices for PBMs.
Sandler O'Neill upgraded the bank to Hold from Sell.
MKM Partners says Motorola's mid-range Android devices have flopped.
Morgan Joseph upgraded the wheels and tires maker to Buy.
Despite a recent bounce, shares of the beer giant are still cheap.
The restaurant chain operator, which just posted solid quarterly results, should eventually derive most of its earnings from China.
Wedbush says larger U.S. markets may only see modest billboard growth.
Sterne Agee cut earnings estimates based on lower net interest margins.
Texas Instruments' manufacturing strategy isn't in the same league.
Credit Suisse initiated coverage at Outperform with a $44 target price.
MasterCard and Visa settled an antitrust lawsuit with the Department of Justice. However, American Express is wisely fighting back.
Credit Suisse says Masco, Mohawk Industries and USG will feel some pain.
Caris & Co. raised the price target on the e-commerce servicer to $40.
T. Rowe Price's Tim Parker shares his favorite natural-resources names.
A sales bump at shops at least a year old is a promising sign. (At SmartMoney.com.)
United Technologies has a lower profile than some other industrial titans, but its prospects look decidedly bright.
The most awesome thing about this last month's surge in stocks is that it was pretty much a "look-mom-no-hands" performance.
Morgan Stanley Asia's former chief Stephen Roach thinks Congress' proposed trade sanctions are a potentially dangerous misstep.
With double-digit yields, Brazil's government bonds are drawing strong interest from investors around the world. Time to jump in?
Read Full Article »