Jim Armitage: So should we be in a real funk as investors rush into buying junk?

Global Outlook

Last week I reported how the exotic financial products that blew up the world in 2007 are back with a vengeance. If that wasn't enough to get you stocking up on tinned food and a new bunker in the garden, perhaps a story buried in yesterday's Financial Times might be.

It was all about the return of investors to the junk bond market. There's nothing wrong with junk bonds per se: despite the dodgy name (salesmen prefer the term "high yield"), they are simply loans to companies that have a higher risk than usual of being unable to pay you back. In return for that high risk, they command a higher return for investors.

With interest rates at record lows everywhere else, retail investors are flooding back into junk bonds like billyo. Banks are delighted at this fact, saying that it shows how confidence is surging back into the economy due to better news on jobs and other measures. Perhaps this is right, but is this really a market that retail investors should be backing? They're called junk bonds for a reason, because they can easily turn out to be just that: worthless rubbish.

The general public have pumped some $306m (£203m) into this stuff so far this year – and it's only March.

A banking analyst told me yesterday that this was all fine and nothing to worry about: bonds are fairly easy to understand, after all. People know the risks. But I'm not so sure how well many of these new investors are having the risk explained to them by their advisers. Do they know, for example, that the biggest bond investors in the world, like Bill Gross's Pimco and BlackRock, are warning of a potential junk bond slump around the corner?

It's a general rule of thumb in investing that by the time the poor old retail punter sniffs out a good deal it's time to sell. I'd suggest that time has probably arrived. There will be a lot of scorched fingers by Christmas.

That's bad for those likely to get burnt. But at least any damage would be limited to them, you may say. Possibly. Possibly not.

The problem is that company debt has traditionally been the preserve of medium- to long-term investors – pension funds and insurance companies who hold on to investments until they reach maturity. This is healthy as it creates stability for the borrower and some level of certainty for the funds.

But with the rush of retail money into junk bonds, through mutual or exchange traded funds, you get the high likelihood of extreme volatility, as punters pile in and out at will. So what happens to the medium- or long- term loan for a company when all that retail money runs out of the door? You get a funding gap – the money behind the loan is simply not there. Through absolutely no fault whatsoever of the company borrowing the money.

Clearly, we're not yet in that situation – quite the opposite. But if the money that's flowing in does suddenly retreat, real businesses using the bond market for their debt could be in a lot of trouble.

Gillian Tett, the FT's sage who spotted the last crisis coming, says she doesn't think that's going to happen. Phew. But we really don't know that. In fact, due to the complexity of the way this high yield debt is traded, nobody really even knows how big those potential funding gaps would be if the worst happened.

Not exactly reassuring, is it?

Start your day with The Independent, sign up for daily news emails
News
Bill Gates, founder of Microsoft and co-chair of the Bill and Melinda Gates Foundation
businessUber, Snapchat and Facebook founders among those on the 2015 Forbes Billionaire List
News
news... and what your reaction to the creatures above says about you
News
Jihadi John
newsMonikers like 'Jihadi John' make the grim sound glamorous
News
music
ebooks
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Recruitment Genius: Customer Service Advisor

£15000 - £16000 per annum: Recruitment Genius: A Customer Service Advisor is r...

Ashdown Group: Trainee Consultant - Surrey / South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

SThree: HR Benefits Manager

£40000 - £50000 per annum + pro rata: SThree: SThree Group have been well esta...

Day In a Page

The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn
Yvette Cooper: We can't lose the election. There's too much on the line

Yvette Cooper: We can't lose the election. There's too much on the line

The shadow Home Secretary on fighting radical Islam, protecting children, and why anyone in Labour who's thinking beyond May must 'sort themselves out'
A bad week for the Greens: Leader Natalie Bennett's 'car crash' radio interview is followed by Brighton council's failure to set a budget due to infighting

It's not easy being Green

After a bad week in which its leader had a public meltdown and its only city council couldn't agree on a budget vote, what next for the alternative party? It's over to Caroline Lucas to find out
Gorillas nearly missed: BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter

Gorillas nearly missed

BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter
Downton Abbey effect sees impoverished Italian nobles inspired to open their doors to paying guests for up to €650 a night

The Downton Abbey effect

Impoverished Italian nobles are opening their doors to paying guests, inspired by the TV drama
China's wild panda numbers have increased by 17% since 2003, new census reveals

China's wild panda numbers on the up

New census reveals 17% since 2003