By Daniel Bases
NEW YORK, Jan 12 (Reuters) - Rising Treasury yields are driving investors from safety to riskier assets like stocks but those savvy enough need not abandon credit completely in order to profit.
In the last three months benchmark 10-year U.S. Treasury yields have surged over 100 basis points, a sharp move up most analysts ascribe to an improving economic environment and stronger corporate balance sheets.
The potent combination of unconventional monetary easing by major central banks along with a tax-cut deal in the United States has also boosted the attractiveness of global stocks at the behest of bonds. Fund flows show net redemptions from U.S.-based fixed income funds after two straight years of inflows.
Yet bond plays including triple-C rated high-yield 'junk' bonds, floating-rate and bank loan mutual funds could offer some protection from a rising interest-rate cycle. For a related story click on
Below are some investments highlighted by analysts and fund managers they would consider in an environment where the so-called risk-free rate of interest is rising:
ADAM RICHMOND, CREDIT ANALYST, MORGAN STANLEY, NEW YORK
- High yield debt offers investors a spread cushion in a rising rate environment that high grade credits cannot give. If the economic environment is improving then highly leveraged companies will benefit from the likely positive impact on their earnings. Shortening the duration of the debt portfolio is also suggested.
- Move lower down the high yield rating scale into the CCC-rate bonds given high dollar prices for the BB-rated sector limits the upside potential.
- Sectors that perform relatively well in this environment include: technology, commodity cyclicals such as energy and materials.
- Buy floating rate instruments such as leveraged loans.
- Reducing rate rise risk can also include selling bonds and going long by selling credit default swap protection. Richmond says the transaction is not a call on the credit, rather a way to protect against rising yields.
Examples include:
* Goodyear Tire & Rubber Co 10.5 percent coupon maturing May 15, 2016.
* AK Steel Corp 7.625 percent coupon maturing May 20, 2020.
* MGM Resorts 6.625 percent coupon maturing July 2015
* NRG Energy 7.375 percent coupon maturing Feb. 1, 2016
* Ford Motor Credit 8.00 percent coupon maturing June 1, 2014.
* The Neiman Marcus Group 10.375 percent coupon maturing Oct. 15, 2015.
- Investors who want to keep their full coupon payment can pay a premium to hedge against a large move higher in rates by purchasing a swaption.
WESLEY SPARKS, HEAD OF U.S. FIXED INCOME, SCHRODERS, NEW YORK
- Sparks also likes the high yield sector to give a measure of protection against rising Treasury yields. He also notes these companies by and large don't have as many near-term maturities, at least not until 2013 and 2014.
- Two examples of high yield credits where management is deleveraging their balance sheets and offering substantial coupons are consumer packaging company Reynolds Group's 8.5 percent May 15, 2018 bond and teaching materials company Cengage Learning Acquisitions Inc.'s 10.5 percent Jan. 15, 2015 bond.
- Bank loan mutual funds for their ability to capture periodic LIBOR re-sets. Data from Lipper, a Thomson Reuters service, shows net inflows have doubled in the last 12 months.
For a related graphic, click http://r.reuters.com/rev75r
* Among the best performing funds in the group are the Pioneer Floating Rate Trust fund -- the top performing bank loan fund in 2010, returning 17.71 percent. Over five years, the Nuveen Floating Rate Income Opportunity fund is the best performer with total returns of 5.08 percent.
- Commercial mortgage backed securities (CMBS). 'We expect to see some new issues in the next month or two such as conduit deals from dealers,' says Sparks. Conduit transactions typically aggregate loans warehoused by a bank.
- Cautions on emerging market sovereign bonds. 'In some sense it was overbought last year... I would say the question is, over the next 6-12 months, where is there going to be continued credit improvements? There are a number of CCC (rated) industrials that are still deleveraging where they are focused on using cash flow to pay down debt whereas a lot of sovereigns are not necessarily improving their credit quality. That was the story in emerging markets the last 10 years.'
WASIF LATIF, VICE PRESIDENT OF EQUITY INVESTMENTS AND PORTFOLIO MANAGER, USAA, SAN ANTONIO:
- Likes: Large-cap U.S. high quality equities. Defines high quality as companies with strong balance sheets and not an excessive amount of debt. 'Information technology has exhibited characteristics of this type of quality,' Latif said.
- Likes: Dividend-paying stocks in a rising rate environment based on the idea that inflation pressures make dividend paying companies more attractive.
- Likes: consumer staples provide protection against rising rates as people continue to buy food, healthcare products, etc. Also an area that provides 'decent' dividends.
- Caution on using exchange traded funds. 'These are primarily implementation vehicles. I would caution that all ETFs are not equal.'
- Asset allocation: overweight U.S. large-cap stocks and emerging markets. Offset by underweight in developed markets such as Europe and Japan and underweight U.S. small cap stocks due to their strong rally. The small-cap benchmark Russell 2000 stock index rose 25 percent in both 2009 and 2010. Keywords: INVESTMENTS RATES/SCENARIOS (daniel.bases@thomsonreuters.com; +1 646 223 6131; Reuters Messaging: daniel.bases.reuters.com@reuters.net; Editing by Andrew Hay) COPYRIGHT Copyright Thomson Reuters 2011. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.
NEW YORK, Jan 12 (Reuters) - Rising Treasury yields are driving investors from safety to riskier assets like stocks but those savvy enough need not abandon credit completely in order to profit.
In the last three months benchmark 10-year U.S. Treasury yields have surged over 100 basis points, a sharp move up most analysts ascribe to an improving economic environment and stronger corporate balance sheets.
The potent combination of unconventional monetary easing by major central banks along with a tax-cut deal in the United States has also boosted the attractiveness of global stocks at the behest of bonds. Fund flows show net redemptions from U.S.-based fixed income funds after two straight years of inflows.
Yet bond plays including triple-C rated high-yield 'junk' bonds, floating-rate and bank loan mutual funds could offer some protection from a rising interest-rate cycle. For a related story click on
Below are some investments highlighted by analysts and fund managers they would consider in an environment where the so-called risk-free rate of interest is rising:
ADAM RICHMOND, CREDIT ANALYST, MORGAN STANLEY, NEW YORK
- High yield debt offers investors a spread cushion in a rising rate environment that high grade credits cannot give. If the economic environment is improving then highly leveraged companies will benefit from the likely positive impact on their earnings. Shortening the duration of the debt portfolio is also suggested.
- Move lower down the high yield rating scale into the CCC-rate bonds given high dollar prices for the BB-rated sector limits the upside potential.
- Sectors that perform relatively well in this environment include: technology, commodity cyclicals such as energy and materials.
- Buy floating rate instruments such as leveraged loans.
- Reducing rate rise risk can also include selling bonds and going long by selling credit default swap protection. Richmond says the transaction is not a call on the credit, rather a way to protect against rising yields.
Examples include:
* Goodyear Tire & Rubber Co 10.5 percent coupon maturing May 15, 2016.
* AK Steel Corp 7.625 percent coupon maturing May 20, 2020.
* MGM Resorts 6.625 percent coupon maturing July 2015
* NRG Energy 7.375 percent coupon maturing Feb. 1, 2016
* Ford Motor Credit 8.00 percent coupon maturing June 1, 2014.
* The Neiman Marcus Group 10.375 percent coupon maturing Oct. 15, 2015.
- Investors who want to keep their full coupon payment can pay a premium to hedge against a large move higher in rates by purchasing a swaption.
WESLEY SPARKS, HEAD OF U.S. FIXED INCOME, SCHRODERS, NEW YORK
- Sparks also likes the high yield sector to give a measure of protection against rising Treasury yields. He also notes these companies by and large don't have as many near-term maturities, at least not until 2013 and 2014.
- Two examples of high yield credits where management is deleveraging their balance sheets and offering substantial coupons are consumer packaging company Reynolds Group's 8.5 percent May 15, 2018 bond and teaching materials company Cengage Learning Acquisitions Inc.'s 10.5 percent Jan. 15, 2015 bond.
- Bank loan mutual funds for their ability to capture periodic LIBOR re-sets. Data from Lipper, a Thomson Reuters service, shows net inflows have doubled in the last 12 months.
For a related graphic, click http://r.reuters.com/rev75r
* Among the best performing funds in the group are the Pioneer Floating Rate Trust fund -- the top performing bank loan fund in 2010, returning 17.71 percent. Over five years, the Nuveen Floating Rate Income Opportunity fund is the best performer with total returns of 5.08 percent.
- Commercial mortgage backed securities (CMBS). 'We expect to see some new issues in the next month or two such as conduit deals from dealers,' says Sparks. Conduit transactions typically aggregate loans warehoused by a bank.
- Cautions on emerging market sovereign bonds. 'In some sense it was overbought last year... I would say the question is, over the next 6-12 months, where is there going to be continued credit improvements? There are a number of CCC (rated) industrials that are still deleveraging where they are focused on using cash flow to pay down debt whereas a lot of sovereigns are not necessarily improving their credit quality. That was the story in emerging markets the last 10 years.'
WASIF LATIF, VICE PRESIDENT OF EQUITY INVESTMENTS AND PORTFOLIO MANAGER, USAA, SAN ANTONIO:
- Likes: Large-cap U.S. high quality equities. Defines high quality as companies with strong balance sheets and not an excessive amount of debt. 'Information technology has exhibited characteristics of this type of quality,' Latif said.
- Likes: Dividend-paying stocks in a rising rate environment based on the idea that inflation pressures make dividend paying companies more attractive.
- Likes: consumer staples provide protection against rising rates as people continue to buy food, healthcare products, etc. Also an area that provides 'decent' dividends.
- Caution on using exchange traded funds. 'These are primarily implementation vehicles. I would caution that all ETFs are not equal.'
- Asset allocation: overweight U.S. large-cap stocks and emerging markets. Offset by underweight in developed markets such as Europe and Japan and underweight U.S. small cap stocks due to their strong rally. The small-cap benchmark Russell 2000 stock index rose 25 percent in both 2009 and 2010. Keywords: INVESTMENTS RATES/SCENARIOS (daniel.bases@thomsonreuters.com; +1 646 223 6131; Reuters Messaging: daniel.bases.reuters.com@reuters.net; Editing by Andrew Hay) COPYRIGHT Copyright Thomson Reuters 2011. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.