First up, Barron's Income Investing:
Loan Rate Sensitivity Is ‘Real’ But Not Significant – Barclays
Leveraged loans are known for being floating-rate, ultra-low-duration investments that income investors can buy without fear that rising interest rates will lead to price erosion, unlike fixed-rate bonds. But are loans really completely rate-insensitive? Barclays credit strategists Bradley Rogoff and Eric Gross examine the issue this week and find that certain correlations definitely exist.I always get tripped up by locutions such as "5.5 times lower" but maybe that's just me.
Barclays points out that 88% of loans today have Libor floors, meaning they guarantee a minimum base rate, which is currently above the corresponding market rate. (I wrote at length about this topic in my April 26 Current Yield column.) Barclays uses a few assumptions to gauge rate sensitivity:
Clearly, loan coupons become fixed when Libor is below the floor, affecting rate sensitivity…. As it turns out, despite an average Libor floor of 105bp and 3m Libor at 23bp, the price of the loan index is not all that sensitive to rates. Shifting the Libor curve in 25bp increments, the average price of the index drops pretty nominally….Barclays says loans’ rate duration is currently 0.76, or roughly 5.5 times lower than the duration of the Barclays U.S. High Yield Index, but Barclays says the empirical duration of both asset classes is considerably lower than these calculated measures suggest...MORE
From Tabb Forum, more on the reach for yield:
What Is a Basis Point Worth?
Ten years ago, no one wanted to inconvenience themselves to try to pick up a few basis points. But today's investors are falling over themselves to collect those very same basis points. Here are 6 risky strategies to combat a flattening yield curve – and why you probably should avoid them.
Ten years ago I started working in Japan as a fixed income sales trader for an international investment bank. I was frequently called upon to travel to other parts of Asia, including Beijing, Hong Kong, Seoul, Singapore and Sydney. My mandate was to invite clients to explore the many money making opportunities available to them by trading the (G4) U.S., German, U.K. or Japanese yield curve.
The touchstone recommendation always seemed to be some combination of going long or short U.S Treasuries and establishing an offsetting position in like maturity German Bunds. Most of our trade ideas were simple variations of a basic mean reversion strategy – optimistic to pick up a few basis points along the way.
After my pitch, I was frequently met by the same incredulous reaction: "Eddie, we are not interested in making a few basis points. ... We want full points, preferably in multiples of 10." No one wanted to inconvenience themselves and stoop down to try to pick up 10, 20 or even 50 basis points! Of course, being in Asia, the clients were always very professional and extremely polite, but my colleagues and I usually left empty handed. We did not win a lot of new business out there....MORE
...So what do you do when you are now faced with a diminutive and none-too-generous yield curve – and you need income? Here are some (very risky) strategies:
- Sell a Tail- increase leverage and borrow on margin; borrowing money to increase long exposure is effectively selling the left tail in a distribution of potential outcomes.
- Sell Volatility- sell options outright and or engage in covered call writing.
- Sell Convexity- or go long instruments like MBS or callable bonds.
- Sell Quality- that is, go long lower rated, more risky instruments, such as High Yield.
- Sell Liquidity- that is, buy highly illiquid instruments like Emerging Market debt denominated in local currency.
- Buy Structured Products- that is doing all of the above in one handy trade.
