Pension funds in the Netherlands have significantly increased their allocations to high-yield bonds over the past two years, according to an overview published by regulator DNB.
Since the outbreak of the coronavirus pandemic in March 2020, the Dutch pension sector’s allocation to high yield bonds has increased from around 7% to almost 11% of bond portfolios.
According to DNB, the greater appetite for high yield bonds is a result of the low yield environment which has made it increasingly difficult for pension funds to earn acceptable returns on their bond portfolios.
“The decline in bond yields has led to a search for yield among pension funds,” noted DNB. This led pension funds to swap some of their investment grade bond holdings for high yield bonds.
The move has paid off for pension funds so far, as high-yield bonds have significantly outperformed their investment-grade counterparts over the past two years. As investors lost money on their investment grade bond holdings due to rising interest rates, high yield bonds rose in value.
The change in the interest rate environment with rates rising from record lows did not materially change the situation. This is because the higher coupon payments and shorter duration of high yield bonds make them less vulnerable to rate hikes than investment grade bonds.
“What’s interesting today is investment grade credit which looks particularly risky,” said John Mawby, investment manager at Pictet. However, high yield bonds are not without risk either, with the specter of a recession looming.
After all, if the macroeconomic situation deteriorates, high-yield bond default rates should rise from their current lows.
“We can indeed see a recession coming,” said Andrew Wilmont, European high-yield portfolio manager at Pictet. However, high yield bonds have the advantage of having shorter durations, he added. “It makes it more likely for investors to get their money back.”
Percentage of high yield bonds of total bond holdings by sector