The low interest rates of this decade are making the profitability-seeking strategy of large investment funds is changing. The traditional market was very clear, very compartmentalized, but it is becoming less so and the barriers are blurring.
The problem is that with low interest rates, the interesting profitability is concentrated in higher risk operations. And where before there were some funds that invested in certain places now the chain has moved and there is jostling.
Investing in bonds high yield is fired
Investing in bonds is considered the most conservative possible. In this case, it is invested in a product with a defined price, which may vary during its listing, but which at maturity the money is recovered and during its possession an annual coupon is paid.
However, coupon returns have plummeted. Public debt cases are clearly unprofitable. For example Spain’s five-year bonds yield 0% and those of 10 years only 0.5%. If we go to more attractive countries, these returns are negative.
So traditional bond investors are migrating to bonds high yield, that is, junk bonds. Bonds with a credit rating below investment grade. They are bonds that do offer moderately attractive coupon returns but whose risk is much higher: there is an uncertainty that at maturity it will be possible to recover the invested.
And where just a decade ago it was practically impossible for a private investor to buy bonds high yield (only available to professional investors) is now really simple through multiple ETFs that trade them.
Investing in listed companies is not enough
On the other hand, there are the funds that traditionally invested in listed companies. Due to the search for profitability of all investors, shares of listed companies are expensive, or so many actors think. And to find more attractive returns you have to go to investment in unlisted companies (private equity).
This type of investment has a big drawback and it is liquidity. Banks are normally limited in their exposure for regulatory reasons, but some funds are moving part of their investment to unlisted companies. And what was once exclusively for institutional investors is now reaching more massive funds.
The funds of private equity to him venture capital
Water continues to rise and those who previously sought profitability in unlisted companies find new competitors and move up the chain. And what was once a land exclusively for money venture capital (VC) now not so much.
A paradigmatic case is that of Tiger Global, a very large fund specialized in private equity which is now doing large ventures in Venture Capital (in late stages). They are very agile and in 2021 they are accelerating this type of investment.
Which pushes the traditional Venture Capital towards even earlier stages of financing. In Spain there was recently a movement in this direction, with K Fund launching a specific seed investment program (Seed), K Founders.
And this, in turn, pushes the business angels, which are left without a market because a company that is being set up will almost always prefer money from a fund than from an individual, since it will allow the following rounds to be lifted more easily.
More profitability but more risk
In all this process of seeking profitability, the truth is that the whole chain is taking more risk. Bond funds investing in high yield and therefore not being a safe investment. Funds that traditionally went only for listed companies that now invest in private equity but in exchange for less liquidity. The funds of private equity that are put in earlier stages of the companies and therefore when the business is not consolidated. And the VCs, specialists in the stages of growth, who enter the capital of companies when it is still just a bet, an idea.
This whole process is creating a dangerous situation, as the risk increases but perhaps the final investor is not appreciating it. And in addition, the risk may be even greater as the fund managers are leaving their zone of control. AND if you invest in something uncontrolled the risk can be even higher.
Therefore, be careful with these movements. When investing in a fund you have to be clear about what strategy they are following and also if they have changed from the past. Past returns do not guarantee future ones, but even less so if they are using novel strategies.