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Oct. 28 (Bloomberg) -- Debt investors are funneling 17 times more cash into hedge funds than into junk-bond funds that returned more in each year since the crisis, heralding a shift from chasing yields to preserving cash as interest rates rise.
Hedge funds that seek to profit without making large bets on the direction of debt prices received $20.6 billion in the first nine months of 2013, compared with a net $1.2 billion put into junk-bond mutual funds, according to data from Hedge Fund Research Inc. and EPFR Global. The flows are a reversal from 2012, when $72.1 billion deposited into the mutual funds was almost twice the $41.4 billion allocated to hedge funds.
Pension plans, endowments and other institutional investors facing the sparsest bond gains since 2008 are leading the charge into hedge funds that returned about half as much as a broad index of high-yield bonds in the four years after the seizure in credit markets. Investors who’ve been led into riskier assets as the Federal Reserve pushed benchmark yields to record lows are now seeking insulation as rising rates erode returns with economists predicting the central bank will slow its stimulus next year.
“They’re getting nervous about the withdrawal of central bank liquidity,” Monica Issar, the head of J.P. Morgan Asset Management’s endowments and mid-sized pensions group, said in a telephone interview. “In the credit space, it’s not as easy anymore. You need skilled managers, people who can trade in significant market turmoil.”
BlueCrest Capital Management LLP, the London-based firm led by former JPMorgan Chase & Co. trader Michael Platt, has increased its assets by $7.2 billion since the end of 2011 to $35 billion, according to a person with knowledge of the matter. Pine River Capital Management LP, founded in 2002 to pursue opportunities in global relative-value trading, boosted its assets by $8.2 billion since January 2012 to about $13.6 billion.
Relative-value hedge funds, which make both bullish and bearish wagers to profit from price discrepancies between securities, have posted average annualized gains of 12 percent in the four years since 2008. That’s about half the average 21.6 percent return each year for the Bank of America Merrill Lynch U.S. High Yield Index.
Almost five years after the Fed started pumping more than $3.27 trillion into the financial system to spur economic growth, investors are struggling to find assets that will hold their value as the central bank considers slowing its stimulus.
After returning an average 11.3 percent annually the previous four years, corporate bonds globally are on pace to gain 1.6 percent this year, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index. That would be the worst annual return since the market lost 7.5 percent in 2008 amid the worst financial crisis since the Great Depression.
The debt plunged 2.2 percent in the three months ended June 30, the worst quarterly loss since the period ended September 2008, as benchmark borrowing costs rose after Fed Chairman Ben S. Bernanke outlined a road map for the central bank to reduce $85 billion of monthly bond purchases if the labor market showed sustainable improvement.
“People always viewed bonds and long-only bond funds as a stable anchor to their portfolio,” said Chris Paolino, senior vice president and head of hedge-fund investments at Hartford Investment Management Co. “What we got this summer was we showed people interest rates could go higher along with stock prices going down. It made people question the efficacy of the protection of their bonds.”
The hedge funds are being looked to as a buffer even after the loosely regulated investment vehicles were blamed for exacerbating the crisis five years ago. By using derivatives and borrowed money to boost leverage in an effort to amplify returns, the funds instead magnified losses after markets seized up when Lehman Brothers Holdings Inc. filed for bankruptcy protection, Fed Bank of New York researchers Jaewon Choi and Or Shachar wrote in a report this month.
Dollar-denominated junk bonds lost 31 percent in the three months after Lehman’s September 2008 collapse, Bank of America Merrill Lynch index data show.
During the bond-market selloff this year, hedge funds fared better than broader market gauges. The funds declined 1.2 percent in June, less than half the 2.6 percent loss on dollar- denominated junk notes and the 2.4 percent decline for investment-grade and high-yield corporates globally, according to HFR and Bank of America Merrill Lynch index data.
“Hedge fund strategies look more conservative than what we saw pre-crisis, with larger cash balances and less leverage employed,” Andrew Sheets, a London-based credit strategist at Morgan Stanley, said in a telephone interview. “What is driving allocation into credit hedge funds isn’t really a reach for yield, but a search for volatility-adjusted returns.”
BlueCrest’s $1.9 billion Multi-Strategy Credit Fund gained 4.4 percent in the nine months through September, more than the 3.8 percent gain on the Bank of America Merrill Lynch U.S. High Yield Index in the period. Last year, the fund rose 7.2 percent, less than half of the 15.6 percent returns on dollar-denominated junk bonds.
“You’re seeing flows into credit-focused funds that can go long and short,” said Ken Heinz, president at HFR in Chicago. “Those flows are coming in at a time when interest rates are low and widely expected to increase.”
Economists who had forecasted the Fed to slow its bond purchases last month now expect the central bank to maintain the pace of the stimulus through the first quarter of 2014 after a 16-day government shutdown this month furloughed as many as 800,000 federal workers. The closing, which Standard & Poor’s said trimmed at least 0.6 percent from economic growth this quarter, also disrupted collection and publication of economic reports the Fed says it needs to determine whether the expansion is strong enough to taper.
Policy makers probably will pare the monthly pace of asset buying by 18 percent to $70 billion at their March 18-19 meeting, according to the median of 40 responses in a Bloomberg News survey of economists.
After the Fed’s Sept. 18 decision to maintain the purchases, corporate-bond yields that reached as high as 4.37 percent on Sept. 5 dropped to 3.9 percent, the Bank of America Merrill Lynch index data show. Yields are 1.9 percentage points below the 10-year average. In June, when yields rose 0.48 percentage points, the notes plunged 2.7 percent, the data show.
“People want to have strategies that look to preserve capital and profit modestly,” Hartford Investment’s Paolino said. “Most investors haven’t had exposure to a rising rate environment for a long, long time.”
Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds worldwide instead of government securities declined for a third week. Sales of the securities surged to the most this month. Loan prices rose, reaching the highest in more than a month.
Relative yields on investment-grade bonds from the U.S. to Europe and Asia narrowed 1 basis point last week to 139 basis points, or 1.39 percentage points, according to the Bank of America Merrill Lynch Global Corporate Index. They’ve tightened from a more than eight-month high of 161 on July 1. Yields declined to 2.87 percent from 2.92 percent on Oct. 18.
The Bloomberg Global Investment Grade Corporate Bond Index has gained 1.69 percent this month, erasing a loss for the year to gain 0.23 percent in 2013.
The cost to protect corporate bonds from default in the U.S. was little changed after reaching the lowest in almost six years. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, increased 0.4 basis point last week to 71.7 basis points.
The measure fell to 70.1 on Oct. 22, the lowest since November 2007 in data that adjust for the effects of the market’s shift to a new version of the index in September.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 1.8 to 86.7.
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of Verizon Communications Inc. were the most actively traded dollar-denominated corporate securities by dealers last week, accounting for 3.4 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The New York-based telephone carrier raised $49 billion on Sept. 11 in the largest corporate bond issue ever.
Wells Fargo & Co. led $85.6 billion of corporate-bond issuance globally last week, a 53 percent increase from the previous period and the most since $92.7 billion was sold in the week ended Sept. 27, Bloomberg data show.
Wells Fargo, the largest U.S. mortgage lender, raised $3.5 billion Oct. 21 in a two-part issue that included $2 billion of 5.375 percent senior notes due November 2043 paying 170 basis points more than similar-maturity Treasuries. The securities rose 1.2 cents from the issue price to 100.9 cents on the dollar to yield 5.314 percent, Trace data show.
The S&P/LSTA U.S. Leveraged Loan 100 index rose 0.34 cent to 97.91 cents on the dollar, the highest since Sept. 23. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, has returned 3.93 percent this year.
In emerging markets, relative yields widened 2.6 basis points last week to 331.5 basis points, according to JPMorgan’s EMBI Global index. The measure has averaged 313.1 this year.
--With assistance by Jesse Westbrook in London and Sarika Gangar in New York. Editors: Shannon D. Harrington, Alan Goldstein