Conference Presentation, Panel, Fireside Chat
The Hunt for Yield: Risk-Free Return or Return-Free Risk?
Milken InstituteJames Mackintosh, Scott Evans, Robert Kricheff, AJ Murphy, Anne Walsh, Andrew Whittaker, James McInstosh, Bob Krychev
- Government bond markets are expected to persist in a "return-free risk" environment with significant price volatility, where long-duration instruments like 40-year Japanese bonds face potential losses exceeding 20% despite the dynamic not being fully recognized by all investors.
- A low interest rate environment is projected to last for "very long time periods," potentially mirroring historical spans of 20 years or more where rates remained under 3-4%, creating a backdrop where investors are encouraged to maximize exposure to the risk spectrum if the economy avoids a severe downturn.
- Fixed income teams plan to maintain exposure to thin-risk-premium asset classes while remaining defensive, anticipating being slightly under-exposed to duration and risk across high-yield, private credit, bank loans, and government bonds.
- Specific high-yield opportunities include second lien loans yielding 200 to 300 basis points above comparable unsecured bonds, smaller high-yield deals under $300 million offering a 150 to 250 basis point pickup, and first-time issuers commanding a 100 to 175 basis point premium.
- Structural imbalances in the loan market are driven by significant CLO formation, creating high demand in the first lien loan market, while liquidity premiums have increased for smaller bonds due to the institutional minimum trade size requirement rising from $100 million to nearly $500 million.
- Market participants anticipate active debt managers will significantly outperform the industry average in treacherous markets, though a "late-stage bull market" for bonds suggests increasing volatility and potential spikes in defaults with recoveries worse than in previous cycles.
- Despite concerns about leverage at low price points and widespread covenant-lite provisions, the panel does not currently identify a leverage bubble in the U.S. market, noting that LBOs and dividend deals have not reached "astronomical" levels and triple-C issuance remains low.
- The credit cycle is described as being at the "9.30" mark on a 12 o'clock peak to 3 o'clock contraction clock, with expectations that regulatory or tax reforms could trigger a shift toward better growth at any moment.
- The Federal Reserve is expected to normalize the market by allowing agency mortgage-backed securities to migrate off its balance sheet rather than actively selling assets, a process the panel believes could lead to significant repricing in the second half of the year.
- U.S. agency mortgage-backed securities (RMBS) are viewed as historically overpriced, prompting plans to radically reduce exposure to this sector as the Fed unwinds its balance sheet.
- Retail and ETF-focused investors may face liquidity risks during "liquidity events," particularly if they attempt to sell large issues simultaneously, a risk heightened by the increasing average maturity of the fixed income market and the prevalence of retail holdings in certain products.
- Significant volatility and potential liquidity crunches are anticipated during the "summertime" or in response to geopolitical news from Europe, as markets currently lack a geopolitical risk premium despite potential regime shifts.
- European high-yield bonds are trading too tightly relative to their liquidity profile compared to the dollar market, and while the ECB maintains a dovish position, a pullback is expected by the end of the year.
- The retail sector faces specific risks from technological disruption and potential liquidity events, while emerging markets require caution unless investing in commodity-based dollar revenue companies due to currency strength and geopolitical uncertainty.
- The 10-year Treasury yielded 2.31 percent at the time of speaking, a level considered low given expectations for rising rates, while the dollar is expected to have room to run if fiscal policy and economic growth progress.
- A pivotal event in the French election is identified as a potential catalyst that could derail global markets, and traders inexperienced in rising rate environments or defaults may react disproportionately to normal market cycles.
- Private lending and direct lending are becoming crowded trades with excess dry powder chasing private equity sponsor deals, necessitating "great, great caution" due to high concentrations of similar assets.