Nathaniel Popper, reporting in the New York Times, has a good piece on how individual investors are plowing into junk bonds just as they are getting more risky. (NYT) This continues the trend of yield chasing we have documented with our coverage of Energy plays in Master Limited Partnerships here.
The scenario is simple, the Fed has cut interest rates to near zero and intends to keep them there for the foreseeable future, while at the same time the baby boom generation is retiring at an accelerating pace. These retirees need income but don’t want the risk of equities. Unfortunately, they are running right into the teeth of the bubble forming in risky income plays. Like all bubbles, it will end badly.
Here are some highlights from the article:
- Junk bond issuance has reached record levels this year
- The average credit rating of companies issuing junk bonds has declined
- The proceeds of many of these offerings are not going to operations, but to cash out private equity funds
- Retail investors added $2.1 billion in the first three weeks of October, while institutional investors sold $256 million over the same time period
- Retail investors added $22 billion to junk bond funds this year compared to $8.3 billion in all of 2011
- LBOs are back in vogue
- More and more junk bonds are issued that allow the borrowers to skip interest payments
For those of you who have been around for a while, this all sounds like the years leading up to the collapse of the junk bond market in the early 1990’s. (PIK bonds anyone?)
Key takeaways for investors and industry participants:
- Investors should beware of the increasing risk in these yield plays, both from an investment cycle and individual investment perspective;
- Compliance/supervisory officers should beware of seemingly high allocations to fixed income that are actually invested in speculative or aggressive high yield bonds or other risky income investments; and make sure the accounts are coded for such investments and that the advisor and investor are both fully aware of the risks