With leverage rapidly rising while credit spreads approach record lows, high-yield bond markets have long since lost any sense of sanity with regard to forward-discounting... but that hasn't stopped the world's biggest bond managers (and now Japan's pension fund GPIF because as they say "now they have a chance to chase higher returns without taking on much risk") from diving in while the water is warm. With the smell of risk essentially removed from any and every market, why not pile into the riskiest credits, gain some extra yield (for free) - what could go wrong?

As the WSJ reports, among the 10 largest U.S. bond funds at the end of 2013, the four with the fastest growth in assets since 2008 held an average 20% exposure to junk bonds and the massive and always controversially-political GPIF has decided that selling bonds when they lose thir investment grade rating means a big loss of potential to profit and despite expectations for wider spreads, has decided to increase its exposure to BB or lower-rated bonds. Market, meet bag-holder... The Japanese Pensioner.

As we have noted before, credit no longer follows fundamentals...

Japan's Pension fund is getting set to load up on junk...

GPIF only investing in overseas debt rated investment-grade reduces chances to gain higher returns, fund official says in minutes of March 27 investment-committee meeting released today. GPIF official responding to question from investment-committee member on why fund has decided to buy bonds rated BB or lower GPIF official: Fund’s external managers often say that even if a security is downgraded to BB or lower, some regain their BBB rating, so selling them when they lose that rating means a big loss of potential to profit GPIF official also says that until recently the fund had been really strict about investment grades; now they have a chance to chase higher returns without taking on much risk by diversifying their assets, and so will add high-yielding bonds to asset mix Investment committee member: GPIF results for 5 yrs through Dec. 2013 have been good but environment was supportive as interest rates were low and credit spreads narrowed Rates are more likely to rise than fall in next 5 yrs and credit spreads will probably widen, so GPIF needs a structure that takes into consideration rising interest rates: committee member

And the world's largest bond managers are already bloated... (via WSJ)

A handful of managers have elbowed their way to the top of the bond-fund world by loading up on riskier debt.



Among the 10 largest U.S. bond funds at the end of 2013, the four with the fastest growth in assets since 2008 held an average 20% of their investments in bonds rated below investment grade, also known as junk bonds, according to an analysis by The Wall Street Journal.

"Who wants an index fund that yields 2%?" said Jeffrey Gundlach, whose Total Return Bond Fund at DoubleLine Capital LP has $32.1 billion under management, up 10 times from its start four years ago. Mr. Gundlach, in an interview, said investors "want exposure to these high-yield and distressed securities and they've become comfortable with what we're doing." Junk bonds typically offer investors a higher interest rate, or yield, to make up for the risk of default. ... Investors in junk corporate bonds like Mr. Lee draw comfort from low corporate default rates below 2%, but the chase for yield has pumped junk-bond prices up to near-record highs, leaving them susceptible to selloffs, analysts said. Mr. Lee said he is watchful for investors to pull out of the market should they sour on bond funds, as they did last summer.

What could go wrong?

"The air goes out of the balloon faster than it goes in, so we might add another percent or two of cash or Treasurys to our portfolio," he said. ... "Sales of assets from any of those funds could create contagion effects on the related funds, spreading and amplifying the shock and its market impacts," the Treasury said in a September report on the systemic risk posed by large fund managers.

Well that we guess! And the good old Japanese pensioner will be wearing the "kick me" short when it's all over.