(Bloomberg) — As equities take more pummeling, more traders are hiding out in credit markets.
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They’re finding refuge in top-quality bonds, especially short-term securities. So far this year, global investment-grade credit funds have absorbed almost $70 billion, making it the biggest inflow for this part of the year since EPFR Global started tracking the data in 2017.
“Why would you subject yourself to this very data dependent, binary, weekly equity environment with rates repricing, when you can sleep at night sitting in Treasury bills or short-duration investment-grade credit,” said Charlie McElligott, cross-asset macro strategist at Nomura Securities International.
He offered his own anecdotal evidence, saying he knows equity fund managers that have stocked their portfolios with between 25% and 50% of short-term bonds from blue-chip companies.
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Against a backdrop of high inflation and a Federal Reserve determined to keep raising rates, asset allocators face the challenge of picking the least-bad option. Stocks have taken a beating recently, bond prices are under pressure from Jerome Powell’s hawkish warnings and the value of cash is being eroded.
“In the near-term, cash and investment-grade credit are the best way to be positioned,” said Thomas Hempell, head of macro and market research at Generali Investments. “Although it will not be a stellar performance.”
The S&P 500 tumbled on Tuesday, bringing losses to 4.6% from a peak in early February, after Powell said interest rates will probably need to be higher than previously expected. US equity funds have seen four weeks of outflows totaling $10.6 billion, according to EPFR data.
The risk for investors shifting to credit is that they’ll be locked into securities with a long time horizon, leaving them exposed to losses as interest rates climb. And for all the optimism about high-grade bonds, the total return is less than 1% this year, based on a Bloomberg Index. The average note in the benchmark yields 5.3% and matures in almost nine years.
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“It’s very much a short-term tactical hiding spot,” said McElligott, warning that the “tourists” from the equity market may sell as soon as there’s a durable bull market.
The more adventurous types may start reaching into speculative-grade debt to get even more yield. Gershon Distenfeld, the co-head of fixed income at AllianceBernstein, said he expects lower-quality fixed income will be competitive with stocks for the next few years.
“People are seeing that you can probably get the same kinds of returns with a lot less risk by being in the same parts of the fixed income market rather than equity markets,” he said.
But for now, the clamor is for high-quality debt. That’s caused spreads to narrow to historically tight levels, which suggests that investors care more about the absolute yield than relative valuation.
The difference in yield between a three-month Treasury bill and the investment-grade index is only 0.7 percentage point, according to data compiled by Bloomberg. The spread between high-grade and three-month T-bills recently hit record lows, according to JPMorgan Chase & Co. strategists.
“In terms of the flows that we are seeing, there are some equity investors shifting into credit,” said Jill Hirzel, a London-based investment specialist at Insight Investment. “Investment-grade technicals are still looking attractive.”
–With assistance from Cecile Gutscher, Denitsa Tsekova, Dani Burger, Dan Wilchins and Josyana Joshua.
(Updates hdeadlines at bottom of the story)
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