How Reaching For Yield Ends

After six and a half years at 0%, savers and investors are beyond tired of waiting for the Federal Reserve to raise interest rates. They are desperate and reaching for yield wherever they can find it.

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Last June, Janet Yellen famously noted that there was “some evidence of reach for yield behavior.” Indeed, just as there is some evidence of snow during a snowstorm. Dr. Yellen has since gone silent on the subject as we all know the proximate cause of this desperate reach has been the Fed’s unwillingness to let go of Mr. Zero.

The reach for yield has taken many forms, from investors buying longer-term bonds to riskier bonds to high yielding equities. Unfortunately, none of these are good options for investors seeking safety in yield and all require a higher risk tolerance than most investors appreciate.

Take, for example, the Senior Loan ETF (BKLN). This is a portfolio of leveraged loans with an average credit rating of BB. With all-time low yields last year and deteriorating credit standards, investors certainly had little appreciation of what they were buying. They just knew they needed more than 0%, and Senior Loans were one way to reach for a higher yield.

The result? A year later, Senior Loans are marginally lower. Not terrible, you say. At least they had the chance of a higher yield. Perhaps, but investors would have been better off in a high yield savings account earning 1%, which is truly risk-free. In buying senior loans they were hoping for a risk-free higher return and what they received was return-free risk.

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Similarly, in Junk or High Yield bonds (HYG), investors have been accepting a high level of risk over the past year in exchange for a negative total return.

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These are of course benign outcomes in the midst of an economic expansion and overall bull market. What happens when the cycle turns? In 2008, leveraged loans and high yield bonds declined over 30%. How many investors buying these instruments today are willing to accept anything close to a 30% drawdown?

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Disclaimer: This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer ...

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