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Dutch large investors do not expand investments in high-risk bonds
Dutch institutional investors such as pension funds, investment funds and insurers kept their investments in risky bonds roughly the same over the past 12 months. This is a break from previous years: since 2019, large investors had expanded their exposure to what are termed high-yield bonds.
Published: 29 November 2023
High-yield bonds are an attractive investment option because they offer higher returns due to their comparatively higher risk (see box). With bond yields particularly low in recent years, institutional investors found it worthwhile to allocate more of their assets to high-yield bonds. However, since the recent interest rate hikes, they are also receiving higher interest rates on the less risky “investment grade” bonds.
As at 30 September 2023, Dutch institutional investors held €68 billion in high-yield bonds, representing some 10% of their aggregate bond portfolio. A year ago, this figure stood at €71 billion. The decrease must be attributed to price and exchange rate movements, given that purchases and sales were almost equal.
Of the Dutch investments funds’ aggregate bond portfolio, just over 16% (€14 billion) consists of high-yield bonds. For pension funds, this percentage stands at over 10% (€51 billion), and for insurers at just under 3% (€3 billion).
Pension funds also hold indirect investments in high-yield bonds through investment funds. These investments declined significantly in mid-2022, as pension funds wound down their holdings in high-yield investment funds and managed the investments themselves. This had a considerably smaller percentage impact on pension funds' high-yield bond holdings, as their direct investment portfolios are significantly larger.
What are high-yield bonds?
Credit rating agencies, of which Moody's, S&P and Fitch are by far the largest, assess the creditworthiness of individual bonds and of the governments and firms that issue them. The credit ratings they issue reflect the probability of firms or governments being unable to meet their payment obligations. In addition, they factor in the expected loss a creditor faces if the issuer of the debt security should default.
Credit ratings are expressed on a scale, and most market operators use them as guidance in taking their investment decisions. ‘AAA’ is the highest possible credit rating. By contrast, ‘D’ is the lowest, indicating that the issuer is in default, having failed to meet one or more payment obligations. As a firm or government’s creditworthiness remains the same or changes, agencies can from time to time confirm previously issued ratings or upgrade or downgrade their debt securities.
Ratings of BBB- and up are commonly referred to as 'investment-grade', while those of BB+ or lower are known as 'high-yield'. As the latter category carries a higher probability of default, investors demand a higher interest rate in compensation.
Ratio of high-yield corporate bonds to high-yield government bonds
Of the high-yield bonds in the portfolios of Dutch institutional investors, two-thirds (€46 billion) were issued by firms.
Within this category, US firms are particularly popular among Dutch investors. As at 30 September, Dutch institutional investors had allocated almost €21 billion to bonds issued by US firms such as Ford, American Airlines, KFC and Uber. European firms outside the Netherlands ranked second at €12 billion. Finally, Dutch high-yield corporate bonds accounted for just over €3 billion.
Institutional investors also hold €22 billion in high-yield government bonds, investing mainly in the BRICS countries Brazil and South Africa, which account for €11 billion. The government bonds of the BRICS countries India and China are considered investment-grade.
High-yield bonds were more often upgraded than downgraded in the past 12 months
As of 30 September 2022, 15% (€10 billion) of high-yield bonds held by institutional investors were upgraded to a higher credit rating. In contrast, 11% (€8 billion) of high-yield bonds were downgraded.
A credit rating downgrade typically reduces the value of a bond, thereby reducing the value of an investor's investment portfolio. Conversely, when a bond is upgraded, its value goes up, increasing the value of the investment portfolio.
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