Investors looking to increase their returns from fixed income should stop equating increased liquidity with increased risk, says Apollo Advisors managing director and head of yield product development, Seth Ruthen.
Tectonic shifts in the bond market, including a prolonged low-interest-rate environment and an upswing in popularity of direct lending, have made attractive yields harder to come by and trades have become overcrowded, Ruthen argued.
Buyers who aren’t price sensitive – mostly central banks and exchange-traded funds (ETFs) – are creating distortions, meaning the biggest market dislocations are in the most easily accessed parts of fixed income markets. Ruthen said this a big problem now, and is set to become an even bigger one when these buyers become price-insensitive sellers.
“In the most liquid markets, half of government bonds yield less than global inflation; 24 are negative, but there was a time when you could get a 5 per cent yield from government bonds,” he said.
Higher yield is usually synonymous with increased duration and lower credit quality but that doesn’t have to be the case, he argued.
“A lot of really interesting things are falling through the cracks, which makes them a responsible way to deal with the risk, for properly underwritten securities,” he said.
Ruthen made his comments at the 2017 Investment Magazine Fixed Income, Cash and Currency Forum, in Healesville, Victoria, in July.
In his presentation to the gathering of institutional fixed income specialists, he identified his firm’s three primary risk factors as duration, credit quality and liquidity.
In the past, people have tended to conflate low quality with liquidity but Ruthen said that is not universally true and the two can be separated.
The liquidity sweet spot is five days to 20 days, Ruthen said, “because it’s just outside where the ETFs, the central banks and the ’40 Act [liquid alternative] funds can trade”.
He stressed that value right now is not found in the primary or secondary markets, rather through direct or indirect origination, buying off a seller’s balance sheets.
“The way credit is handled in portfolios is changing and liquidity needs to be thought of more in terms of a continuum,” he said.
Apollo Advisors’ move towards direct origination was to sidestep an otherwise crowded market, Ruthen explained. However, he warned that “tourist capital” – investors dipping into a particular sector to find bargains – won’t result in strong deals. Investors need permanent resources in a sector to open the network for off-market paper or direct origination, he said.