Years of low interest rates have sparked an intense search for yield, with many investors seeking heftier returns in riskier corners of financial markets. So-called yield plays, including real estate investment trusts (Reits), master limited partnerships (MLPs), some initial public offerings, leveraged loans, and the bottom tier of the corporate credit market, have offered relief for the return-ravenous, rate-restrained investor.
With an interest rate hike from the Federal Reserve now widely expected to take place next month, however, some of the air has been firmly kicked out of yield plays' tires. Risk appetite appears reduced, and investors seem to be growing more discerning when it comes to just where they are putting their money to work.
Here's a rundown of some markets that are emitting the proverbial hissing sound.
1. Cracks in corporate credit
Perhaps the biggest beneficiary of years of low interest rates has been the corporate bond market, which has exploded in size as companies seek to take advantage of cheaper funding costs and eager investors. While the junkiest of junk-rated bonds have produced the highest returns for investors in recent years, that trend appears to be reversing as portfolio managers become more selective about the risks on their own balance sheets.
2. Tamed unicorns
While Square, a stalwart of the unicorn club of private companies with market values upwards of $1 billion, traded higher on Thursday following its initial public offering, worries over the the loftiness of its and other startups' valuations persist. Even trading above its offering price of $9 a share, Square's market value is still far below the $15.46 a share it sold stock for in its last private funding round. Other negative news of late from the world of unicorns includes leaked Lyft financials that show the ride-sharing startup isn't meeting its own projections. Fidelity has also written down the value of its Snapchat investment by 25 percent.
3. Unwanted leveraged loans
Loans made to companies with relatively fragile balance sheets surged, thanks to low interest rates and competition among underwriters, prompting some regulators to voice concerns over the business. The past couple of weeks have seen a reversal of fortune for the sector, however. Investors have shied away from taking down the debt resulting from Carlyle Group's takeover of Symantec’s data-storage business, the biggest private equity buyout of 2015. Banks led by Morgan Stanley are also said to be offering investors a deep discount to buy debt backing Sycamore Partners’ acquisition of retailer Belk after struggling to attract interest in the loan.
4. Worries over yieldcos
The corporate structure known as a yieldco found popularity in recent years with power companies. Such yieldcos, formed to own and operate power plants, lured investors keen to capitalize on their higher yields and dividend growth. The structures have had a tougher time of late, however, with two poster yieldco children owned by SunEdison, the solar power company, under particular scrutiny. Shares of SunEdison and its two yieldcos, TerraForm Global and TerraForm Power, have been clobbered as investors fret over their respective levels of indebtedness.
5. Master limited partnerships adrift
The MLPs that populate the energy sector have been hit with a double whammy from the collapse in commodities prices and the prospect of looming higher interest rates sparking contagion in the corporate credit market. Bloomberg Gadfly columnist Liam Denning points to the Alerian MLP index, spreads of which used to move more in synch with oil prices than with junk bonds. In the past month, however, its correlation with the BofA Merrill Lynch U.S. High Yield Index has jumped to 51 percent vs. just 27 percent for oil, data compiled by Bloomberg show.
6. REITs take a seat
Real estate investment trusts and their income-generating property portfolios have ridden a wave of low interest rates and eager investors to expand their empires and share prices in recent years. But the prospect of higher rates and the heftier borrowing costs that would come with them has left many REITs suffering in recent weeks. Shares of a number of REITs have declined as the potential interest rate hike nears.
7. BDCs have targets on their backs
Business development companies that make loans to midmarket businesses have also been buoyed by the low interest rate environment as well as fallout from the financial crisis. Often labeled as members of the "shadow banking system" of nondeposit financial institutions, they've moved to fill the gap left by banks that are no longer willing or able to extend credit to certain companies in the wake of new regulations. But some of the shine appears to have come off the BDC business model in recent weeks, with share prices of a number of the companies now trading below their book value. That's prompting a flurry of interest from activist investors, including Elliot Management and RiverNorth.
8. Newly listed companies aren't looking so fresh
Yield-hungry investors seeking to pad their portfolios have sometimes looked to newly listed companies for a little pop. Many of the companies that went public in recent months have been trading below their offering prices, however, including the highly anticipated offerings of GoPro, Etsy, and LendingClub.
Whether these examples spur broader contagion or remain isolated incidents of released market steam remains to be seen.