Analysis-'Few places to hide': investors seek shelter as stocks, bonds fall together

[February 18, 2022]  By Davide Barbuscia

NEW YORK (Reuters) - Lockstep declines in bonds and stocks are sending investors into defensive products such as credit swaps, convertibles and even cash as they seek refuge from the market’s recent gyrations.

BlackRock Inc's iShares iBoxx $ Investment Grade Corporate Bond ETF has fallen by nearly 7% year-to-date to its lowest level since April 2020, as expectations of higher interest rates and persistent inflation dim the allure of bonds across the fixed-income spectrum.

That is in line with losses across major stock indexes, which have also been hit by worries of tighter Fed policy. The S&P 500 has dropped 7.3% year-to-date and the Nasdaq Composite is down by about 11%.

The side-by-side tumbles have dealt another blow to a decades-old strategy that relied on a mix of bonds and stocks to take the sting out of equity declines, with bond prices ideally moving higher during periods of stock market volatility.
 

"It's very difficult right now because there's just very few places to hide," said Jordan Kahn, president and chief investment officer at ACM Funds in Los Angeles.

The search for defensive products comes amid worries of more volatility across asset markets, as an expected 150-175 basis points in rate increases over the next year threatens to further buoy bond yields and weigh on stock valuations.

Yields on the benchmark 10-year US Treasury, which sway borrowing costs across the credit spectrum, are up 50 basis points this year, to their highest level since August 2019. Bond prices move inversely to yields.

"Widening spreads and volatility have certainly brought back interest to products that had been basically sleepy for the past few years,” said Alfonso Peccatiello, a former portfolio manager who now authors a financial newsletter and advises institutional investors.

For some investors, anticipation of more wild swings in asset prices has heightened the appeal of credit swaps, which are used to ensure against the risk of corporate defaults.

The Markit CDX North American Investment Grade Index, a basket of credit default swaps that serves as a gauge of credit risk, widened over 17 basis point to 64 basis points this year, its highest level since September 2020.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., March 19, 2020. REUTERS/Lucas Jackson

Matt Smith, investment director at British fund manager Ruffer Investment Management, said he did not have any corporate credit in his portfolio but owns "quite a lot" of credit default swaps.

"Credit is ... vulnerable to either yields going up, or central bank accommodation falling back, or flows out of credit, meeting quite an illiquid market. To us, it looks like the worst of all worlds", he said.

Michael Miller, president and chief investment officer of Wellesley Asset Management, an investment firm specializing in convertible bonds, said demand for such instruments - which allow holders to convert bonds to their underlying equities - has been on the rise.

Miller said they have almost always outperformed other asset classes such as U.S. equities or traditional fixed-income instruments during periods of inflation in the last 50 years.

"This rather forgotten asset class all of a sudden has been getting a lot of attention all over again," he said.

The SPDR Bloomberg Convertible Securities ETF, an exchange-traded fund that provides exposure to the market of U.S. convertible securities, has climbed 0.3% this month.

Kahn, of ACM Funds, increased exposure late last year to an ETF that moves inversely to Treasuries to hedge against higher rates, as well as to hybrid instruments linked to the energy transportation industry.

He is also relying on a more traditional strategy for uncertain times: cash. The cash balance in his portfolio now stands at its highest level since March 2020, when the pandemic wreaked havoc on markets.

"Right now I think that we're in a market where just preserving capital is more important than seeking return on capital", he said.

(Reporting by Davide Barbuscia in New York; Editing by Ira Iosebashvili and Matthew Lewis)

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