June 4, 2018

Investors Divesting Long Term Investments for Short-Term Loans

Excerpt

Investors are exiting long-term investments and moving into short-term loans and bonds to manage risk stemming from climbing interest rates, historically low yields, and an unimpressive stock market.

Post

Short-term debt instruments are receiving massive investment inflows. In the week ending May 11, for example, Bloomberg reports that investors bought $1.8 billion in short-term fixed-income debt. That's roughly 1.4% of total assets. 

Government bond funds are recording some of the heaviest investments of the past 12 months. An exchange-traded fund (ETF) specializing in short-term bonds, the iShares 1-3 Year Treasury Bond ETF, received inflows of $1.1 billion in a week. It was the highest level of investment in the fund seen since 2014 and in the top 5 of allocations into investments listed on U.S. exchanges, both stock and bonds.

Interest rates are rising, which can pose risks to portfolios.

Short-Term Instruments Are a Risk-Management Method

These large inflows are occurring because investors are leaving long-term investments for short-term bonds. Why?

The large investments in short-term debt instruments are in part risk management strategies for 3 potential portfolio risks: 1) rising interest rates; 2) historically low yields on debt instruments; and 3) the stock market’s relatively lackluster performance so far this year. 

The risk of rising rates…

Interest rates have been rising steadily for nearly 18 months, and the U.S. Federal Reserve has indicated an intent to hike them more going forward. 

While climbing rates are good for bond yields overall, yields move inversely to bond prices. An environment of rising rates, therefore, means that bond prices will fall. For lending institutions with bond portfolios, that results in a negative portfolio return.

The institutions can buy short-term debt instruments to mitigate the risk attendant on falling bond prices, without having to hold them for the long term. 

Short-term loans and bonds can be a risk management tool.

The risk of low yields

While long-term bond yields have risen since the beginning of the year, standing at 3.07% now versus 2.41% in January, they are still at historically low levels. Given the expected increase in interest rates long term, institutions are smarter to purchase short-duration assets as rates, continue to go up and the yield curve flattens.

Once the yield curve reverses the current flattening, longer-term debt instruments will become more prudent. For now, though, short-term bonds are the solution to the potential problem of being locked into low long-term yields.

Stock market risk

While the stock market always carries more risk than bonds, there is also greater opportunity for profit maximization. 

So far this year, though, the Standard & Poor’s 500 has risen only 1.6%. Portfolio managers, however, likely see increasing risk in the stock market, for several reasons. 

First, the current average yield for dividend-paying stocks is 1.9%. That compares unfavorably with both short- and long-term bonds, and may encourage investors to pursue bonds rather than stocks. That can place pressure on prices.

Second, the bull market is long by historical standards. At some point, markets are likely to retrench or trade sideways rather than continue an upward march.

Third, rising interest rates often dampen stock prices, both by making debt instruments more attractive and making money more expensive to borrow. Higher interest rates can put a crimp in business expansion, which can cause less than impressive profits — and the latter can put a damper on prices.

Let an Experienced Loan Sale Advisor Help

Periods of rising interest rates can be volatile for institutional portfolios. Lending institutions need to manage risk and optimize returns at all times. Let an experienced loan sale advisor like Garnet help you purchase high quality portfolios to do both.

Sign up for our newsletter for insight.