Some big investors are getting so antsy about corporate junk debt that once-unloved mortgage bonds look safe in comparison.
Pacific Investment Management Co., Goldman Sachs Asset Management, Columbia Threadneedle and others are snatching up bonds tied to subprime mortgages and other home loans made before the housing crisis, while selling speculative-grade company debt. They say junk yields are too low for the risk investors are taking, and securities backed by mortgages -- which have already gained as much as 6.9 percent this year according to Bank of America Corp. data -- offer higher potential returns given the risk.
These switches in portfolios are the latest sign that a bull market in corporate credit may be losing steam. In the decade after a financial crisis caused by the U.S. subprime meltdown, many investors dialed down their exposure to mortgage bonds and ramped up their holdings of corporate debt, which performed well in late 2008 and 2009 and often seemed safer. Now the U.S. mortgage market is showing signs of strength, and at this stage in the credit cycle buying securities linked to home loans may make sense, even if it may mean giving up some yield, investors said.
‘Highest Conviction’
“Housing has got legs,” said Mark Kiesel, chief investment officer of global credit at Pacific Investment Management Co, which manages $1.6 trillion. “It’s the sector we probably have the highest conviction on.”
Kiesel said he expects housing prices to appreciate, which will help non-agency mortgage securities, or bonds backed by home loans without government guarantees. If instead home values falter in a mild recession, the securities can still eke out positive returns. Pimco recommended trimming exposure to high-yield bonds and equities and shifting to less risky assets like mortgage-backed securities and Treasuries in an asset allocation report this month.
The market for non-agency mortgage-backed securities has shrunk dramatically since the financial crisis. There were about $800 billion outstanding in the middle of 2017, down from $2.8 trillion a decade ago, according to the Securities Industry and Financial Markets Association, a trade group.
Bank of America, using a different data set, says about 37 percent of the securities are backed by subprime loans. The rest are supported by other mortgages ineligible for government guarantees, such as “jumbo” loans that are too big for U.S. backing. While some firms have issued these notes in recent years, the majority of the securities outstanding were originally sold before the financial crisis.
“There’s lots of demand and shrinking supply,” said Mike Swell, co-head of global fixed-income portfolio management at Goldman Sachs Asset Management, which manages more than $1 trillion and has been reducing high-yield exposure in favor of mortgage-backed securities and other structured products. “We think it will be much better protected in the event that volatility picks up and you see risk assets like high yield do poorly.”
Higher Gains