“Who wants an index fund that yields 2%?” said Jeffrey Gundlach, whose Total Return Bond Fund at DoubleLine Capital LP has $32.1 billion under management, up 10 times from its start four years ago. Mr. Gundlach, in an interview, said investors “want exposure to these high-yield and distressed securities and they’ve become comfortable with what we’re doing.”…

…Junk bonds typically offer investors a higher interest rate, or yield, to make up for the risk of default. The development underscores the intense demand for investment returns that has characterized the financial markets since the 2008 crisis. Prodded by uneven economic growth, expansive central-bank policy and low interest rates, investors are gobbling up riskier assets like never before.”, Wall Street Journal, May 28, 2014

“I have posted similar articles on this blog, during the past year or so, to support my contention that pre-financial crisis investors did not buy riskier MBS (and other) securities because they were fooled by issuers into doing so (securities disclosure fraud)….they knowingly bought them to enhance their own profits and hoped the worst would never happen. As this article notes, individual investors are pouring into bond funds with heavy concentrations of risky junk bonds, because they are not satisfied with very low, Fed-engineered rates for safer securities. And these institutional investors who manage these bond funds are investing in higher concentrations of riskier junk bonds to turbo-charge their fund’s performance relative to the competition to garner more assets and more asset management fees. This is one of the major unintended consequences, when free markets and competition are distorted by Fed low-rate monetary policies. The Fed’s easy money policies, over time, essentially force more and more investors to capitulate and take on greater and greater risk, than they might otherwise wish to do.”, Mike Perry, former Chairman and CEO, IndyMac Bank

 

MARKETS

New Fund Stars Ride Junk Bonds to the Top

Development Shows Demand for Returns Since 2008 Financial Crisis

By MATT WIRZ

May 27, 2014 8:44 p.m. ET

A handful of managers have elbowed their way to the top of the bond-fund world by loading up on riskier debt.

Among the 10 largest U.S. bond funds at the end of 2013, the four with the fastest growth in assets since 2008 held an average 20% of their investments in bonds rated below investment grade, also known as junk bonds, according to an analysis by The Wall Street Journal of data from Morningstar Inc. At the remaining six funds, low-rated debt accounted for 1.4% of the portfolio.

The development underscores the intense demand for investment returns that has characterized the financial markets since the 2008 crisis. Prodded by uneven economic growth, expansive central-bank policy and low interest rates, investors are gobbling up riskier assets like never before.

 

The biggest bond funds, led by Bill Gross‘s $230 billion Total Return Bond Fund at Pacific Investment Management Co., have long relied on safe, high-rated government and corporate debt. But in the era of record-low interest rates engineered by the Federal Reserve, money has flocked to fund managers who have bought into lower-rated debt such as junk bonds, emerging-market debt and mortgage securities.

“Who wants an index fund that yields 2%?” said Jeffrey Gundlach, whose Total Return Bond Fund at DoubleLine Capital LP has $32.1 billion under management, up 10 times from its start four years ago. Mr. Gundlach, in an interview, said investors “want exposure to these high-yield and distressed securities and they’ve become comfortable with what we’re doing.”

Junk bonds typically offer investors a higher interest rate, or yield, to make up for the risk of default. The strategy particularly paid off last year, when investors fled risk-free government bonds and higher-grade corporate bonds as U.S. interest rates rose.

High-yield corporate bonds returned 7.44% in 2013, including interest payments and price gains. The Barclays U.S. Aggregate bond index, which includes no junk-rated debt, lost 2% last year.

The U.S. Treasury Department has warned that large holdings at the big funds may pose a systemic risk to financial markets.

The managers climbing into the top echelon include Mr. Gundlach, who founded Los Angeles-based DoubleLine, and Robert Lee of Lord Abbett & Co. Some more-conservative fund families, such as American Funds, have dropped out of the top 10 as they eschew junk debt. Megafunds run by Vanguard Group Inc., best known for rock-bottom fees, haven’t increased their holdings of junk bonds.

The two other newcomers to the top 10 are a Pimco high-income fund and a government bond fund run by Franklin Templeton Investments. None were in the ranking when the financial crisis hit, but since then, they have attracted investors by outperforming more conservative funds. The four fastest-growing funds returned an average of 2.1% in 2013.

Mr. Gundlach’s fund holds about 80% of its assets in mortgage-backed bonds, with 28% of its investments in high–yield debt in December. DoubleLine purchases low-rated bonds at discounted prices, so the fund can still make money if they default, said Mr. Gundlach. The fund has returned 5.91% annually over the past three years, versus a 3.83% average for comparable funds, according to Morningstar.

Investors in junk corporate bonds like Mr. Lee draw comfort from low corporate default rates below 2%, but the chase for yield has pumped junk-bond prices up to near-record highs, leaving them susceptible to selloffs, analysts said. Mr. Lee said he is watchful for investors to pull out of the market should they sour on bond funds, as they did last summer.

“The air goes out of the balloon faster than it goes in, so we might add another percent or two of cash or Treasurys to our portfolio,” he said.

One concern for regulators is that if hit with a wave of redemptions from investors, the funds could have trouble unwinding their bets in the smaller high-yield markets, where trading can dry up quickly when prices start to fall.

“Sales of assets from any of those funds could create contagion effects on the related funds, spreading and amplifying the shock and its market impacts,” the Treasury said in a September report on the systemic risk posed by large fund managers.

The prospect of fire sales of bonds by large funds “may create trouble in terms of transmitting crisis from one sector of the fixed-income market to another,” said Massimo Massa, a professor at French business school Insead who studies the impact of mutual funds on markets.

Five of the top 10 bond funds by assets are managed by Vanguard, each with less than 1% invested in high-yield securities. Vanguard, based in Valley Forge, Pa., said it can offer competitive returns without buying risky debt because it charges lower management fees than competitors.

Pimco’s Total Return Bond Fund is the world’s largest and has long posted market-beating returns, but it lagged behind many rivals last year as interest rates climbed. Investors have pulled $55.3 billion from the fund since May of last year, when the Fed said it would ratchet back its bond-buying program. All told, assets in the fund posted a 17% decline last year.

In comparison, Mr. Lee’s fund at Lord Abbett, which is based in Jersey City, N.J., grew by $5 billion, or 19%, in 2013. The fund has returned 3.6% annually over the past three years, double the category average, according to Morningstar.

“We’ve gone out the risk spectrum some,” said Mr. Lee, who began buying high-yield mortgage bonds and corporate bonds aggressively in 2009 when their prices collapsed. “The fundamentals of corporate America are still pretty good and default rates are pretty low.”

Write to Matt Wirz at matthieu.wirz@wsj.com
Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved
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Posted on May 28, 2014, in Postings. Bookmark the permalink. Leave a comment.

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