The Wall Street Journal-20080123-Where to Find Yield Now- Some Tiptoe Into Old and Risky Haunts
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Where to Find Yield Now? Some Tiptoe Into Old and Risky Haunts
When the Federal Reserve pushed interest rates sharply lower earlier this decade, investors had to make hard decisions about where to put their money to earn decent returns.
The problem is back with a vengeance.
Yields on Treasury securities are sinking fast, leaving investors with the prospect of skimpy returns in bonds. Yesterday, yields on 10- year Treasury notes sank to 3.484%, their lowest since June 2003. The yield on two-year Treasury notes fell to 2.060%, their lowest since April 2004.
In 2005, some investors responded to paper-thin Treasury yields by jumping into risky investments, such as junk bonds, commodities or mortgage bonds backed by subprime housing debt. This time, it looks like an especially dangerous move, though some investors are warily taking it.
Pension funds in particular, with heavy commitments to retirees coming due, are in a quandary. They need high yields to meet their obligations, but the housing crisis has also made them wary of risk.
Still fresh in many of their minds is how the low interest-rate environment from earlier this decade inflated numerous bubbles. Some bubbles, such as the housing market, have already burst; others, such as emerging markets, look increasingly vulnerable.
"Normally, people chase yield when rates fall," said Jeremy Wolfson, senior investment officer for the $8.5 billion Los Angeles Department of Water & Power pension fund. "But I don't think people will take on additional risk for yield right now."
Yet, some are already doing just that in limited doses. Bill Gross, manager of bond-fund giant Pacific Investment Management Co., known for its Pimco Total Return Fund, says he is looking to invest in areas that may benefit from the Fed's newly aggressive interest-rate cutting, such as bonds issued by banks and other financial companies.
Yesterday morning, Mr. Gross was buying debt issued by stalwart banks such as Bank of America Corp., Wachovia Corp. and J.P. Morgan Chase & Co., as well as government-sponsored mortgage giants Freddie Mac and Fannie Mae.
Mr. Gross notes that during the last period of low interest rates, in 2003, the two-year Treasury note never went below a yield of 1.5%. "Any common-sensical portfolio manager would say there is limited downside for [Treasury] yields and limited upside for price," he said.
Tad Rivelle, portfolio manager on Metropolitan West Total Return Bond Fund, picked up 10-year debt issued by Citigroup Inc. at a yield two percentage points above the comparable Treasury security. Historically, that debt yields about 0.80 or 0.90 percentage point above Treasurys.
While there may be more bad news ahead for financials, he said he sees the yields as attractive, given that "you're talking about lending to a supreme banking franchise."
There is no consensus on that strategy. Although financial bonds are currently yielding 5.6% on average, that's the same level as a year ago, according to Merrill Lynch data. Jeffrey Gundlach, portfolio manager on the TCW Total Return Bond Fund said he thinks they will be going still higher in yield. "The banking crisis just continues on a bearish path," he said.
Mr. Gundlach is nosing around in the part of the bond market that was ground zero for the current market and economic woes: securities backed by mortgages.
Prices of some higher-quality bonds backed by subprime home loans have come off their lows. The Markit ABX.HE index that tracks triple- A-rated subprime-mortgage bonds issued in late 2005 recently traded at 94.2 cents on the dollar, up from a low of 90.1 cents in November.
"That market is in much better shape. It's already been trashed," Mr. Gundlach said.
Other bond managers are also reaching for yields on mortgage-backed securities but are sticking to better-quality mortgages backed by Freddie Mac and Fannie Mae.
The challenge is that the latest drop in interest rates raises the risk that homeowners will refinance their loans, which is a negative for bondholders.
Since last fall, Thomas Atteberry, a fund manager at First Pacific Advisors, has owned mortgage bonds yielding about 6%. He said he thinks a combination of factors, such as tighter credit standards, will limit refinancing.
But he acknowledges it may make sense to be looking at agency-backed mortgage bonds yielding 5% or 5 1/2%, which should offer more protection from refinancings.
One area where bond-fund managers are still expressing caution is the junk-bond market. Junk bonds are now paying some of their highest yields in years: 10% to 11% on average versus 7.5% a year ago.
But default rates are starting to creep up from near historical lows, which might pressure prices. During the past week, a few companies, including restaurant operator Buffets Holdings Inc. and fabric producer Propex Inc. filed for bankruptcy protection after missing debt payments.
The corporate default rate is still below 1%, but analysts and money managers mostly concur that the rate will rise this year.
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Serena Ng and Craig Karmin contributed to this article.
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AUCTION RESULTS
13-WEEK BILLS
Here are the results of yesterday's Treasury auctions. All bids are
awarded at a single price at the market-clearing yield. Rates are determined
by the difference between that price and the face value.
Applications ..................................... $52,220,921,000
Accepted bids .................................... $21,000,046,000
Accepted noncompetitively ........................ $1,786,241,000
Foreign noncompetitively ......................... $36,500,000
Auction price (rate) ............................. 99.400917 (2.370%)
Coupon equivalent ................................ 2.424%
Bids at market-clearing yld accepted ............. 35.25%
Cusip number ..................................... 912795D99
The bills are dated Jan. 24, 2008, and mature April 24, 2008.
26-WEEK BILLS
Applications ..................................... $63,151,087,000
Accepted bids .................................... $19,000,075,000
Accepted noncompetitively ........................ $1,614,087,000
Foreign noncompetitively ......................... $300,000,000
Auction price (rate) ............................. 99.786667 (2.400%)
Coupon equivalent ................................ 2.470%
Bids at market-clearing yld accepted ............. 64.35%
Cusip number ..................................... 912795F63
The bills are dated Jan. 24, 2008, and mature July 24, 2008.
