The thought came to mind as I read Bill Gross’s latest commentary on the economy and the markets. The co-CIO of PIMCO is not a happy camper.
Gross’s monthly investment commentary, entitled “Devil’s Bargain,” is an angry jeremiad about—well, it’s difficult, actually, to pin down exactly what it is he is angry about, but artificially low interest rates and budget deficits and financial engineering all seem to enter into it. (His prior diatribe, on the consequences of deficit spending, was a model of clarity by contrast.)
But the bottom line is that Gross sounds like he is ready to swear off Treasury bonds and their ilk in favor of higher-yield alternatives, including emerging market debt and high-yield domestic bonds.
That is what we call “safe spread”—the recognition that credit spreads, or emerging market returns, or currencies with positive and high real interest rates are more attractive than those old-fashioned gilts and Treasury bonds offering 2-3%. Those are markets that need to be “exorcised” from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint.
If he takes his own advice, it could mean a significant rebalancing of the PIMCO Total Return Fund, the world’s largest mutual fund with assets of $255.3 billion as of Oct. 15. (At year-end, the fund was 45% invested in mortgages and 22% in government related issues. High-yield was 6%.)
And that could change people’s thinking about fixed income in general and high-yield in particular. According to the mutual fund experts at Lipper, a sister service of peHUB at Thomson Reuters, bond investors withdrew funds from fixed income in December, for a second consecutive month.
And the rate at which mutual fund investors are pulling cash from bonds is accelerating—an outflow of $25.2 billion in December, the most recent month for which data is available, compared to a $1.9 billion outflow in November. Among the few bright spots in fixed income were Loan Participation Funds, which brought in $4.1 billion in December, and High Current Yield Funds, which attracted $1.7 billion, according to Lipper.
In fact, PIMCO is launching a new fund, targeting “senior floating rate debt,” according to Randy Schwimmer, a senior managing director and the head of capital markets at Churchill Financial Group LLC. Other mutual fund complexes, including Prudential and Nuveen, also are targeting the high-yield market.
“There is a real opportunity in the market, based on where they believe interest rates are headed,” Schwimmer told me the other day.
To be sure, this is not a new phenomenon. Fixed-income funds have offered high-yield options for a long time. But given borrowers’ success in pushing out their maturities coming out of the financial crisis, keeping default rates down, and given the dearth of alternatives for yield-hungry investors, both retail and institutional, this could provide another potentially large source of funds for leveraged loans, he said. “All the technicals point to a very good year.”