The convergence of historically high and growing corporate cash balances with historically low interest rates is driving investors to seek higher yields through a higher risk tolerance.
While not everyone is pursuing high yield, the appetite for risk within the NeuGroup’s Treasury Investment Managers’ Group is increasing.
Two areas that remain attractive are emerging markets and direct corporate debt and bank loans.
As for emerging market debt, this sector has been the golden goose for much of the past five years and continues to garner very bullish views. The road to investment grade in these countries continues to be paved with more and more corporations benefiting from growing economies that attract investment.
It’s not all rosy, however. While returns can be quite high, the volatility can be unsettling. Investors clearly need to prepare management for this risk. Depending on the currency of one’s investment, whether in USD or local, there is the added variable of the FX exposure that could work against the actual returns of your investment. Therefore, emerging markets should be approached from a strategic perspective and not a tactical one. But the continued strength of these local economies, with some exceptions – namely Argentina — will drive the bullishness in the sector.
For those comfortable dropping below BBB-rated issues, the two big categories are direct corporate debt and bank loans. Bank loans offer less risk given that they are collateralized. This remains true even as some have raised questions about how much confidence one can really place on collateral. For instance, who is checking that the collateral is there and has the value that is claimed? Still, loans are also a better asset because of more favorable callability options. Loans have a LIBOR floor and a one-year limit on calls, while corporate bonds don’t have a floor and typically have a call limit of two years.
The portfolio of the near term may contain lower-rated corporate issues, but also high yield, emerging market debt, and even collateralized loan obligations (CLOs). These markets are poised to continue to perform well, mostly from carry versus spread tightening. Considering the supporting market technical factors and fundamentals it makes sense to consider these asset classes.