06.22.2012
By Terry Flanagan

Bonds Investors Look To Take On More Risk

With fixed income yields at record lows, many investors, who have lost confidence in the equity markets, are now looking for a little more risk and return from bonds and are going in search of real returns.

“We’re seeing more investors in the high-yield sector of the bond markets,” said Joseph Colleran, managing director and head of trading services at BondDesk, a fixed income technology firm.

Volumes in the two biggest junk-bond ETFs in June have climbed 22% above the six-month average while overall trading for the underlying debt has sunk 9%, according to research compiled by data vendor Bloomberg.

It goes against the grain of the typical logic for moving away from equities and going to the bond market. Fixed income securities are typically looked at as a safe and steady investment, with Treasuries as the de facto choice for investors fatigued by the volatility of equities.

Investing in high-yield junk bonds can seem somewhat “counterintuitive” to observers, noted Colleran. “Typically, when investors get scared they go to the security that the bond market is known for,” he said. “Investors now have more appetite for risk, they’re moving out on the curve because they have to, they’re just not getting the returns they’re looking for.”

BondDesk users have been moving away from the AA and A rated bonds and have been going into BBB and ‘crossover’ bonds, which are the instruments that are on the edge between investment grade and junk status.

Founded in 1997, BondDesk operates the largest retail bond trading venue in the U.S. The company executes about one-third of trading in the retail bond market. It also provides enterprise-wide fixed income trading technology, software and analytical tools to the broker-dealer community. BondDesk ATS, run through an affiliate, connects broker-dealers through a centralized marketplace by offering a diverse pool of liquidity for odd-lot fixed income securities in multiple asset classes. The ATS executes about 20,000 transactions daily, worth more than $1 billion, for a network of 2,000 broker-dealers.

Investors, particularly retail, have been packing up and leaving cash equities in droves for some time now. U.S. stock mutual funds have seen net outflows now for 13 consecutive months, according to research from data provider Morningstar. Actively managed stock funds, both U.S. and international, have seen more than $172.3 billion in assets pulled out of funds over the past year. In May, high-yield bond funds saw net inflows of $1.2 billion in May, after five straight months of strong inflows.

“The fixed income market will remain supported by occasional flare-ups by the European crisis, at least in the first-half of the year,” said Sal Guatieri, senior economist at BMO Capital Markets in Toronto.

Analysts have noted that when some semblance of certainty returns to the markets and the economy as a whole, investors will return to equities. Until Europe’s debt issues and domestic political and fiscal uncertainties are resolved, then confidence in equities will remain low.

“Once the playing field is more identifiable, and people believe that the worst is over, you will see people get back into equities and away from bonds,” said Colleran. “There will also be a force in the other direction. As the demographic gets older, more and more people will be putting their savings into fixed income. You will see fixed income getting a bigger piece because the average demographic is getting older and younger people are saving earlier on.”

While in the past, young investors typically allocated nearly all of their savings into equities and just a small portion into bonds, that has been shifting in the opposite direction following the past few market blow-ups.

With investors increasingly using bonds, new platforms have been springing up to take advantage of the increased demand.

Having operated in Europe for two years, trading platform operator Vega-Chi plans to launch an independent trading platform for high-yield junk bonds in the U.S. later this year, in a move to capitalize on the growing interest among institutions keen to trade with each other directly and cutting out banks as middlemen.

Bulge bracket bank Goldman Sachs plans on opening its own bond crossing platform, GSessions later this year. Asset manager BlackRock recently announced the Aladdin Trading Network, which is intended to cross client bond trades. It has many market participants wondering if it will become more common for the buy side to look to bypass the traditional Wall Street firms with their own trading platforms.

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