Here’s a grim forecast to consider: It may be 2021 before you make any money on investment-grade bonds again.
Morgan Stanley (MS:US) Wealth Management’s Jonathan Mackay predicts the securities will post annual returns of between 1 percent and 2 percent for the next seven years -- which means you’ll lose money after accounting for inflation. That’s a big shift considering the debt gained 8.7 percent annually on average in the 30 years through 2012.
Investors should “have a lower average allocation to bonds than you would have in the previous cycle because they just don’t provide the income and return,” said Mackay, senior market strategist at Morgan Stanley’s $2 trillion wealth management unit. While central-bank stimulus is supporting bond values, “the collateral damage is going to be lower portfolio returns.”
The way to get around this is to buy higher-yielding assets, he said. While higher-rated bonds have been outperforming their riskier counterparts in 2014, that may be poised to reverse.
“What we’re suggesting is that you just have less of your bond allocation in the perceived, or formerly perceived, safe havens of bonds,” Mackay said.
About 45 percent of all government bonds are now yielding less than 1 percent, according to a report yesterday by Bank of America (BAC:US) Corp. analysts led by Michael Hartnett. The Bank of America Merrill Lynch Global Corporate Index has gained 6.5 percent this year, with yields on the notes plunging to 2.6 percent, within 0.17 percentage point of the record low set last year.
Investors have already been plowing into junk-rated debt as well as equities and less-traded assets like real estate and private equity.
There’s also always the possibility of boosting leverage to juice returns, which debt investors have been doing with credit lines and credit-default swaps.
Outstanding bets on a credit-swaps index tied to North American junk bonds have soared to the highest level since at least 2011. Net wagers on the latest Markit CDX North America High Yield Index rose to $34.4 billion as of Aug. 29, compared with a peak of $29.1 billion on the last series in March, according to data compiled by Bloomberg.
All of this risk-taking has been paying off lately, as credit investors largely shrug off escalating geopolitical conflicts and with the speculative-grade default rate less than half its long-term average. High-yield bonds globally are on track to gain 8.9 percent this year, building on the 142.7 percent return during the previous five years, Bank of America Merrill Lynch index data show.
Of course, not everyone’s as sanguine about just reaching for more and more yield. Bank of America analysts recommended yesterday that bond buyers be on the lookout for “signs of investor hubris,” especially with the Federal Reserve set to stop its monthly asset purchases.
But when the other option is losing money, as Morgan Stanley’s Mackay suggests, it’s easy to understand why investors might choose hubris.
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