Fixed-income strategist William Eigen told a standing-room-only crowd at IMCA’s annual conference that traditional fixed-income strategies, the kind that have worked for the past thirty years, aren’t going to cut it in the next year or so.
“Spreads are the tightest they’ve ever been,” said Eigen, head of J.P. Morgan Asset Management’s opportunistic fixed income strategies and absolute return group. The spreads in high-yield bonds in both the U.S. and Europe are so tight they will act like Treasuries. “There isn’t a cushion,” he said. Investors thinking they are getting some protection in high-yield strategies will be shocked at how badly they do when interest rates begin to rise.
Part of that is the lack of liquidity in the bond market, something only exacerbated by the entry of exchange traded funds in the high yield space. When the most widely help bond issues start to sell off, buyers are scarce and bid-ask spreads widen. When it starts to go, “this stuff is relentless,” he said.
Of course, “projecting rates has been a failed prophecy,” he said. Investors went into this year thinking rates were going to go up, instead they fell 40 basis points. Consider the ProShares UltraShort 20+ Year Treasury ETF, a bet on rising rates: it’s down some 20 percent year to date.
“If you call for rising rates and you’re wrong, it assures you get a bad return very quickly,” Eigen said. “The nice thing, however, is the closer rates get to zero, the easier this gets.” Making it tougher for long-only bond investors is that correlation among all sectors of the bond market is moving higher. “On the beta front, when rates rise, there’s going to be no place to hide.”
Eigen’s total return fund is up about 75 basis points this year, and about 60 percent in cash. Traditional bonds are up higher, but that’s okay with him. “When the tide goes out, we’re going to see who's got bathing suits on at the beach.”