Likes dogs that chase cars, investors who chase yield are not acting rationally – and the results can be fatal.
With returns on bonds close to historic lows, many investors are seeking higher yields by investing in riskier assets.
Those who invest for income want the highest yields possible. But they have to keep in mind that high yields result in high risk.
Bond Holders Hit By Hurricanes
Consider Puerto Rican bonds as just one recent example. Even before the island was decimated by hurricanes, Puerto Rican bonds were a shaky investment. As Ian Bezek notes on Seeking Alpha, “Puerto Rico’s 4 million people support a debtload of $72 billion. New York has a similar debtload, but a population of 20 million. Thus, on a per citizen basis, Puerto Rico has 5x more debt than New York – and no one would suggest that New York itself was a model of well-run finances.”
The island features rampant corruption, only 40% of adults are employed and at least 40% of the island’s income is entitlement money coming from the U.S., according to Bezek, yet yield chasers have been drawn to Puerto Rico’s bonds, not only because they pay a relatively high yield, but because they are exempt from local, state and federal taxes. And many assumed the U.S. government would bail out Puerto Rico, mitigating investment risk.
High Yield, High Risk
Calling chasing yield a “form of desperation,” Jason Zweig noted in The Wall Street Journal that exchange-traded funds holding high-yield corporate bonds had attracted $1.6 billion in new money in September.
This happened even as the extra yield investors received on the bonds had essentially disappeared.
Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors, noted that, based on an index from Bank of America Merrill Lynch, yield on high-yield corporate bonds had shrunk by 3.42% since the end of 2015.
Keep in mind that another name for high-yield bonds is junk bonds.
Return chasers, of course, face the same risks as yield chasers. Zweig also mentions a Nasdaq-listed company called Bioptix, which saw its stock price nearly double in a week after announcing that it was changing its name to Riot Blockchain and entering the cryptocurrency business (from $4.11 to $8.18).
As Bioptix, the company had been licensing fertility hormones for cows, horses and pigs. What do the company’s owners know about cryptocurrency? Not much, perhaps, but they seem to understand investor psychology.
Speculators in Riot Blockchain did, indeed, profit short-term, but will the stock value continue to appreciate? As of this writing, the stock price was $8.49, down from an Oct. 11 high of $9.24.
Buying High, Selling Low
Zweig also points out in a previous column that investors have a tendency to buy stocks, bonds and other assets when the prices rise and sell when they drop. In other words, chasing yield or chasing returns can lead to buying high and selling low.
Even seemingly safe investments may be risky investments if they are currently selling at high prices.
“What you’ve seen investors doing is starting to chase other asset classes in a search for yield so they’ve been piling into things that they perceive as safe havens,” JPMorgan’s Stephen Parker said on CNBC’s “Futures Now” recently.
Parker cited the recent popularity of minimum volatility exchange traded funds (ETFs), which invest in “safe haven” stocks, such as utilities and consumer staples. While such sectors offer above-average yields, their valuations currently are exceptionally high.
Buying high and selling low is a sure way to lose money. Dogs don’t know any better, but investors should.