Reaching For Yield In Hot Credit Markets - ninemsn
31.12.69
By Bo Becker and Victoria Ivashina
Fixed-income investors that have targets based on imperfect risk measures are tempted to take on additional risk to raise their portfolio yields. This column argues that when yields are low such 'reaching for yield' may be especially attractive. New research that quantifies reaching-for-yield for corporate-bond investors shows that insurance companies, which are regulated based on broad ratings categories, assume additional risk by selectively overweighting risker bonds within categories. There is evidence that this distorts pricing and issuance.
These are exceptional times in fixed-income markets: US treasuries (of ten-year maturity) currently yield less than 2% per year, the German bunds (same maturity) yield just above 1%, and Japanese government bonds (same maturity) yield less than 0.5%. These low yields on safe assets coincide with unusually low credit spreads. In other words, both safe and risky assets currently provide very low promised returns. For investors who aim to meet return benchmarks or value targets (this includes most institutional investors), this can be an exceedingly challenging situation. They can be tempted to 'reach for yield' by taking on additional credit risk and illiquidity to raise portfolio yields.
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