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Major Asset Managers Have Sharply Different Advice for Bond Investors

Thursday, 30 Apr 2015 05:22 PM

It's no secret that bond investors seeking discernible returns have had a hard time of late. With yields on a large swath of government debt hovering near zero — or even less — the temptation is to move into ever riskier securities to generate some (any!) sort of return. Investing in bonds with a longer-duration can also help boost returns, since investors are typically compensated for bearing the extra risk of long-term inflation or eventual interest rate rises, both of which would tend to erode the yield generated by the investments.

That means investing in long-duration bonds has become a rather popular strategy in recent years.

DoubleLine recommended earlier this week that big investors seeking higher returns (and assets better suited to their portfolios) buy mortgage-backed securities guaranteed by the U.S. housing agencies. 

They make the point that long-duration debt sold by U.S. corporations has been in such demand in recent years, that there's simply not enough to satisfy demand: U.S. businesses have issued record amounts of long-dated debt to lock in prevailing low interest rates. Issuance of long-duration investment-grade corporate bonds has grown from $100 billion in 2008 to $150 billion in both 2012 and 2013.

Even with these large corporate issuances, it is very likely that the demand will outpace the supply, making it tougher to source corporate assets. If rates are to rise it is possible that corporate issuance will decrease, making that mismatch of supply and demand even worse.

While going long duration has become something of a go-to strategy, not everyone agrees with the tactic.

On Thursday, Ben Inker and Jeremy Grantham of GMO, recommended that investors stay far away from such securities.

The difficulty, of course, is finding something else to invest in.

To our minds, any investors who are not required to own long-term government bonds in their portfolios should warmly consider getting rid of them, and those tempted to speculate on the future pricing of bonds may want to consider the benefits of betting that European and perhaps Japanese bond yields will be higher in the future.

The obvious question this recommendation leads to is what to do with the money that isn’t being put in long duration bonds.

We don’t believe that investors should use it as an excuse to buy more equities, but do believe that investors should consider both shortening up the duration of their bond portfolios – the low yields on cash today are a decent trade-off against the possibility of significant losses on bonds in the future – and expanding holdings of alternative investments, such as conservative hedge funds, as well. This makes sense for U.S.-based investors, but is even more essential for investors in Europe and Japan.

 

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2015-22-30
Thursday, 30 Apr 2015 05:22 PM
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