We have frequently discussed the "reach for yield" trade as "lower-for-longer" global interest rate policies have forced investors to seek higher yield through a shift to longer duration and/or lower credit quality. Pensions and insurance firms have been a big part of the tightening on the long end of the curve as they seek to match asset duration with their long-term liabilities…a never ending feedback loop where lower yields result in more forced buying and even lower yields.
But now UBS, in a note issued by Stephen Caprio and Matthew Mish, is asking whether the "reach for yield" trade has turned into a "flight to quality" trade as investors take a more defensive posture across the credit spectrum. A review of global institutional and retail fund flows seems to suggest that the "reach for yield" trade is waning with more money flowing into IG and crossover credits and out of high yield.
The reach for yield theme has dominated our client discussions in 2016. Dovish central banks, low to negative sovereign bond yields, weak global growth and low inflation have conspired to drive investors into all corners of credit to hunt for yield. The result: YTD credit market returns are in the double digits, and corporate borrowing costs have plunged. That is how the story is being told. But is there an unwritten chapter to this story? Is this really a reach for yield, where investors are pouring money into all types of credit? Or does the evidence suggest credit flows are more symptomatic of a flight to quality?
A look at fund flows by domicile of end investor also yields some interesting insights. The biggest take away is that Japanese buyers seem to be fairly indiscriminate in their buying patterns and remain sizable buyers of HY and crossover credits. US and Euro investors, on the other hand, have sold lower-quality HY, in force, in favor of higher quality IG and crossover credits.
Our dataset also allows us to attribute aggregate flows to where the end investor is domiciled. What insight can be gained here? First, Japanese investors are indeed reaching for yield pushing money into both the highest and lowest quality funds. Second, European investors have shown more caution, largely avoiding credits with material default risk, and gravitating toward US IG, EUR HY, and defensive US BB HY funds. But third, the credit bid from US investors is limited. And this is important; the sheet scale of US investor AUM often dwarfs that from EUR and JPN combined, which is a fact often lost in the constant chatter about the global bid for yield. For example, US investors make up 66% of AUM for all speculative grade debt we track (Global HY, US HY, US Bank Loans), vs. only 19% for European and 5% for Japanese investors. This is one reason why US outflows from speculative grade funds have overwhelmed new mandates set up for global accounts.
UBS believes the "flight to quality" trade started as far back as 2014. Per the chart below, since the beginning of the various global QE programs in 2009, cumulative fund flows into high quality credits (blue line – BB rating and above) has been fairly consistent while flows into low-quality credits (below BB rating) seemed to stall in March 2014.
In today's rigged markets it's often difficult to truly understand the motivations of massive pools of pension/insurance capital. After all, its difficult to understand how "lending" money to someone for 10 years and then paying them for the honor of providing the loan makes any sense. That being said, it's hard to imagine how a rotation out of HY can be viewed as anything but negative for global economies as high yield is often the first market to break and typically leads equities lower.
via http://ift.tt/2aWCiUZ Tyler Durden