Private Debt

Here’s another instance of institutions pushing out the risk curve.

Banks once owned the majority of credit assets, leaving institutional investors with limited access to these markets. Although the financial crisis accelerated the banks’ exit from many of these investments, the process had begun earlier in the decade.

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Style drift.

As Central Banks plump their balance sheets with treasuries and mortgage backed securities (and stock market ETF shares … Japan), we should expect to see a push out the risk curve as investors seek yield.  I’ve written about this before.  I’ll be writing about it more, because it makes me nervous.

In trading, smart risk management teams keep an eye out for what we call “style drift”.  Essentially, a trader is good at trading one thing, opportunities in that strategy/market become harder to come by, so the trader starts changing.  He adds more leverage to the same strategy, or he removes some of the hedge (increasing return by lowering the cost of the hedge), or he drifts into ancillary markets (“I know a lot about trading oil, so I probably can make some money in distressed debt of downstream oil and gas companies” … that’s a big leap, but it’s in the right direction).

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Changing Return/Risk

According to EurekaHedge, Hedge Fund launches are down 30% from the 2015-2016 average.  Nobody should be surprised by this … with Central Banks buying every AAA security they can get their hands on (less $50m per month in the US), investing gets pushed out the risk curve.  Pensions/401k providers can’t meet obligations with treasuries, so they move to muni bonds, and then to corporate bonds, and then to equities, and then to alternatives.  The greater the manager’s mandate for risk, the the more quickly he or she moves out that curve.

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