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The Chase for Yield Is On

 November 30, 2012 01:23 PM


That was my thought as I read this article from the WSJ about debt recently issued in Mongolia. You can read the article to learn about Mongolia's recent past but as part of the offering there was a ten year tranche which was priced to yield 5.125% and there was demand for the paper.

Nominally speaking 5% for ten years seems pretty good these days but as one manager is quoted that doesn't adequately compensate the risk for lending money to Mongolia for ten years. The long term prospects for Mongolia are great because of the vast resources in the ground there but the government has done a couple of things that could impede the progress between here and "great." I think of it as being theirs to lose and they could lose.

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The apparent success of the offering is easy to understand which is that yield is harder to come by from the usual slices of the fixed income market and so more investors (both institutional and individual) are going to places that ten years ago would have never occurred to them.

At some point enhancing yield turns into chasing yield and yield chasers often get hurt. A complacency develops about the risk taken by owning certain things and the complacency gets rewarded because nothing bad happens for a while. This is along the lines of a Minsky Moment which is one of the behaviors that was widely discussed after the financial crisis was widely known to have started.

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Some investors mentally minimize the risk they are taking with their yield chasing but there are other investors that I think don't realize they are taking risk. Both sets of investors face the same bad outcome but the behaviors are a little different.

This applies to both equities and fixed income. We are currently in a zero percent world. An equity portfolio that owns a lot of MLPs and mortgage REITs such that the mix yields 7 or 8% is taking a lot of risk. There is no way to know whether or not there will ever be a meaningful consequence for that risk but it is being taken. Similarly a fixed income portfolio heavily concentrated in long dated low quality paper is also taking a lot of risk. There will definitely be investors that successfully trade around that risk and not get hurt but there will be more investors who do not successfully trade around that risk and they will get hurt badly.

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