More bond investors bet on US rate rise

March 19, 2013 7:37 pm

More bond investors bet on US rate rise

By Stephen Foley, Michael Mackenzie and Dan McCrum in New York

More US bond investors are seeking new ways to hedge against the risk of a sharp rise in interest rates in case growth in the world’s largest economy picks up and the Federal Reserve starts to wind up its current stimulus policies.

The US central bank is expected on Wednesday to maintain its current level of bond purchases, which have pushed up bond prices and kept rates low. However, some investors are taking positions in exchange traded funds and leveraged loans that are designed to profit if market interest rates spike higher.

More money has flowed into leveraged loan mutual funds in the first 10 weeks of this year than in the whole of 2012, according to the latest data from Lipper. Loans have floating interest rates and can be used as a hedge against sharply rising rates.

Inflows into junk bonds, which pay a fixed rate of interest and whose value will therefore fall when market rates rise, have proved more volatile after their strong performance last year.

Lipper said $12.4bn has flowed into leveraged loan mutual funds so far this year, compared with a total of $11.9bn for all of 2012.

Carl Eichstaedt, a senior portfolio manager for Western Asset Management, said that he now prefers bank loans to junk bonds. “Because short term rates have been so low for so long, bank loans have been the step child of high yield,” he said.

Mr Eichstaedt also said that due to the policies of the Federal Reserve “short term rates will stay lower than they otherwise should, given the cyclical recovery, but five to 10 year rates could go higher”. He said that he was not expecting an immediate move, “but we don’t want to be the last one left at the party”.

 

As well as loans, some investors have also sought out rare floating rate bonds. Earlier this month, General Electric issued $500m in floating rate debt that matures in 10 years, the first such issue this year. Only about $5bn of such notes have been sold since 2008, according to Dealogic.

Meanwhile, a record volume of bets have been laid against the value of the two largest junk bond ETFs. There has been a 50 per cent increase in the level of so-called short interest in the iShares iBoxx High Yield Corporate Bond ETF in the past month, according to IndexUniverse.

And speculators have borrowed record 26.34m shares in the SPDR Barclays Capital High Yield Bond ETF, the equivalent of 4.85 days’ trading. When traders short such a security, they sell borrowed shares, hoping to return the equivalent to the lender later after buying them more cheaply.

Edward Marrinan, head of macro credit strategy at RBS, said short selling ETFs is a less expensive, and less than permanent, way to bet on rising rates and falling bond prices.

“It takes a long time to build a bond portfolio,” he said. “You don’t want to dismantle your portfolio, given you killed yourself to build it, so what you do is use a lower-cost, more liquid instrument to hedge it.”

Michael Kastner, a principal at Halyard Asset Management, said US Treasury yields look vulnerable if economic data surprises positively.

“Traders and real money investors are looking to lessen their interest rate sensitivity, and are looking at floating rate notes and short dated bonds,” he said.

Michael Hasenstab, who oversees $170bn in global fixed income investments for Franklin Templeton, said: “I fear most people are not well positioned for higher rates.”

He said that the conventional wisdom has been that a bond fund tracking a broad index is considered low risk, but “while this may have worked to dampen risk in the last decade, it is unlikely to work in the next when interest rates rise”.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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