Displaying items by tag: high yield
California Munis in Trouble
California’s high-yield municipal bonds, intended to fund housing for essential workers like police officers and teachers, are under financial stress. The state issued between $8 billion and $10 billion in speculative municipal bonds to convert existing apartments into affordable housing for middle-income families, but these projects are now struggling due to rising interest rates and declining occupancy.
Local agencies often borrowed beyond the purchase price, assuming high occupancy would cover expenses, but that assumption has proven risky as the economic landscape shifts. The bonds, many of which were sold when interest rates were historically low, now face significant challenges as financial conditions tighten.
Experts are increasingly doubtful about the sustainability of this workforce-housing model, which has not yet been tested across different economic cycles.
Finsum: We are in a time for major changes to the muni market as interest rates fluctuate.
Follow the Yield in Emerging Markets
Pakistan and Kenya have made some of the quickest economic turnarounds in recent memory for emerging market economies and as a result investors are buying up their bonds rapidly. This is part of a larger trend as previously neglected debts from countries like Egypt, Pakistan, Nigeria, and Kenya are now appealing again, driven by interest rate hikes and currency market liberalizations.
With falling interest rates in mature markets, these relatively higher yields are enticing. In Turkey, high interest rates have drawn investors back, and Egypt's debt has seen significant foreign investment, supported by currency devaluation and free-floating exchange rates. Investors view these reforms as promising, despite risks such as volatility and potential capital controls.
Potentially prolonged high US interest rates could challenge these markets, particularly for countries with high debt interest payments. Nonetheless, some investors still find local currency bonds more attractive than dollar-denominated debt, seeing the current situation as the beginning of more gains.
Finsum: It might not be too late to chase the yield curve in some of these emerging market economies.
Yield Seekers Should Look at Munis
Bonds are generally lagging behind this year, with the Bloomberg U.S. Aggregate Bond Index down by 3% year-to-date as of April 2022. Municipal bonds are similarly affected, with the ICE AMT-Free US National Municipal Index showing a 1% decline since the year's start. However, pockets of strength exist within the municipal bond space, particularly in high-yield offerings like the VanEck High Yield Muni ETF (HYD), which has seen nearly a 1% increase year-to-date.
Despite the higher risk associated with high-yield bonds, HYD maintains a balanced risk profile, with a significant portion of its portfolio allocated to investment-grade bonds. Offering a 30-day SEC yield of 4.49%, HYD presents an attractive option for investors seeking enhanced yield opportunities, particularly those comfortable with added risk and in higher tax brackets.
Overall, high-yield munis could serve as a credible alternative to junk corporate bonds, especially considering their relative resilience amid rising interest rates and the potential for enhanced returns compared to traditional municipal bond funds.
Finsum: Munis market is capitalizing on the current environment and investors don’t want to miss out.
How Banks Are Fighting Back Against Private Lenders
Over the last few years, Wall Street banks have been losing market share to private lenders. Recently, they have been looking to win back business by serving as intermediaries between private lenders and companies.
Previously, leveraged buyouts were financed by a combination of high-yield bonds and/or leveraged loans, arranged by a major bank or group of banks. And this accounted for nearly a third of investment banking revenue on Wall Street.
However, private lenders have muscled in on this line of business, forcing banks to adopt and come up with their own strategies to remain viable. Banks like Wells Fargo and Barclays have partnered with private credit funds to source deals, advise lenders, and help companies navigate the right steps to secure financing.
Banks also have preexisting relationships with many privately held companies. According to Barclays, private credit funds have $430 billion in uninvested capital. Since the 2008 financial crisis, banks have had more stringent capital requirements. This means it is more desirable to advise and provide services to borrowers rather than take on additional balance sheet risk.
It’s also helping Wall Street banks get through a dry period for deals due to high interest rates, impeding M&A activity. They are able to collect fees from lenders and borrowers. Typically, direct lenders will split fees with the banks that originate the deal, between 25 and 75 basis points.
Finsum: As private lending has displaced a major chunk of Wall Street’s investment banking revenue, banks are adapting by serving as intermediaries for private lenders and borrowers.
Current Environment Amenable for Active Fixed Income
While the Federal Reserve has been successful in lowering inflation over the past 21 months, it still remains uncomfortably high. The consumer price index (CPI) peaked at 9.1% in June 2022 and reached 3.1% in its last reading which remains above the Fed’s 2% target.
Equally relevant, many of the disinflationary impulses which drove the rate of inflation lower have subsided, while there are indications of nascent inflationary pressures budding. For markets, the implication is that the status quo prevails with the Federal Reserve holding rates at 5.50% since July of last year.
While bonds enjoyed a decent rally as the Fed moved from hiking to holding steady, volatility remains elevated due to the current uncertainty about inflation and Fed policy. As a result, the bulk of gains in fixed income proved to be fleeting. According to John Hanock, these conditions are ideal for active fixed income as managers will be able to take advantage of inefficiencies and dislocations caused by the current environment.
The firm believes that active managers will be able to outperform by overweighting quality, intermediate-term bonds, and defensive sectors. It also likes mortgage-backed securities (MBS) due to attractive yields without sacrificing quality. In contrast, it wants to underweight cyclical sectors and high-yield bonds given its concerns about a weakening economy in the second-half of the year.
Finsum: Volatility has risen for fixed income ever since the outlook for inflation and Fed policy have gotten murkier. Here’s why John Hancock believes active fixed income is the ideal way for investors to take advantage of attractive yields.