High Risk Equities are the Rage

With the elections over and the year quickly moving towards its end, investors have turned their attention to capital returns rather than Capitol Hill. Money managers and hedge funds are buying riskier assets such as small cap stocks, emerging market debt and high?yield junk bonds as those sectors have continued to post solid returns.

“What we are seeing is a flight to risk,” said Stephanie Pomboy, an economist at MacroMavens in New York. “With only 33 trading days left, and the rush to generate double-digit returns now begun, the appetite for risk-taking is not surprising,” she said.

To date this year, junk bonds have returned 9.5%, emerging markets over 8%, and small cap equities 13.6%. Investors are still moving into these sectors in hope of more returns. “A lot of investors are chasing yield and a lot will regret what they’ve bought when all is said and done,” said Bob MacIntosh, a portfolio manager at Eaton Vance Management in Boston. MacIntosh thinks the junk market is pricing in too low a premium for both economic and geopolitical risks. Hedge funds emerge as the major buyers in these sectors.

According to Morningstar, an investment research company based in Chicago, the average equity mutual fund has averaged a total return of 11.16 for the same period. Investors have shown a desire for more speculative and volatile assets as the Federal Reserve is unlikely to increase rates soon. Most of the investors think the central bank will cut rates in 2007. In addition, any doubt about the outcome of the elections is now out of the way. The sentiment has helped push the Dow Jones industrial average’s performance, which has returned about 15% year-to-date.

On November 9, investors gorged on $5.7bn of debt issued by HCA in the second-largest junk bond sale ever to help finance its leveraged buyout by a private equity group. HCA offered yields as high as 9.6% given that many Treasury yields are paying less than 5%. The sale came after investors bought $1.1bn in bonds issued by NRG Energy on November 8 and a concurrent $1bn offering by Dutch company Bank Nederlandse.