Investors Face FOMO Risks as Corporate Bonds Hit Record Lows

Investors are currently navigating a market environment characterized by a surge of FOMO, or fear of missing out, which is driving a wave of return chasing. This behavior leads many to invest in trending assets without fully assessing the associated risks. While this approach may yield short-term profits, it often creates distortions across asset classes, resulting in momentum in certain areas while accelerating losses in others.

One glaring example is the recent spike in demand for U.S. corporate bonds, where spreads have fallen to their lowest levels in 27 years. Investors are increasingly accepting lower compensation for credit risk, buoyed by the expectation that central banks will maintain a supportive stance and that economic conditions will remain stable. Nevertheless, this compression in spreads leaves little margin for error. A deterioration in credit quality or a shift in interest rate expectations could trigger a rapid repricing of these assets.

The excitement surrounding artificial intelligence (AI) equities has also reached fever pitch, with stocks in this sector hitting all-time highs. While the long-term potential of AI technologies is significant, key industry figures, including Sam Altman of OpenAI Inc., have cautioned against the formation of a bubble as investment flows into the sector at an unsustainable rate. This blend of speculative enthusiasm and inflated valuations renders AI stocks especially prone to corrections should expectations fail to materialize.

Strategies for Managing Risk in a Volatile Market

Instead of pursuing the most speculative opportunities, investment firms like TriVest Wealth Counsel emphasize the importance of risk management. They focus on established companies with diversified exposure to AI, such as Alphabet Inc. and Apple Inc.. These firms lead in AI innovation and boast strong balance sheets, robust cash flows, and diverse revenue streams to mitigate downside risk. For instance, Alphabet’s integration of AI through its Google Cloud platform and its DeepMind division enhances its value compared to more speculative AI startups. Apple, while not solely an AI company, incorporates AI across its product ecosystem, ensuring continued relevance in hardware and services.

Investors contemplating a shift from corporate bonds to private debt markets may be attracted by the prospect of higher yields. This move can be worthwhile, but careful consideration of the specific segments and portfolio managers is essential to ensure that yields are underpinned by solid fundamentals. The risk of investors growing impatient with underperforming segments could lead to a return to public markets, where performance has been stronger. Such a shift may trigger unitholder redemptions, compelling funds to restrict withdrawals or sell assets at depressed prices.

Alternative Investment Opportunities

Several investment options provide competitive returns without sacrificing liquidity or transparency. One such option is principal-protected structured notes, which currently offer an annual autocall yield of 7.5%. This investment provides downside protection and an attractive yield, particularly when juxtaposed with the FTSE Canada All Corporate Bond Index, which yields approximately 4%.

Another appealing choice is the BMO Strategic Fixed Income Yield Fund, boasting a yield of 7.7% (or 6% after hedging costs). This fund offers exposure to a diversified mix of fixed-income investments while maintaining daily liquidity, a crucial feature amidst current market uncertainties.

For those seeking a blend of dividend yield and growth potential, reallocating funds into Canadian assets can uncover opportunities in stable sectors like utilities. The iShares S&P/TSX Capped Utilities Index ETF is one example, featuring robust companies such as Fortis Inc., Emera Inc., and Brookfield Infrastructure Partners, with a current dividend yield of around 4%. These firms operate in essential industries, providing predictable cash flows that are especially appealing in an increasingly volatile market.

Ultimately, successfully navigating today’s market requires discipline and a commitment to sound risk management. Investors must prioritize liquidity, transparency, and valuation discipline over the allure of corporate bonds, private equity, and high-flying technology stocks. The risks associated with speculative valuations and unproven business models are real and escalating.

By adhering to a well-defined and diversified investment strategy, investors can better manage risk, adapt to changing market conditions, and position their portfolios for long-term success. In a landscape increasingly influenced by emotion and momentum, clarity and control have never been more essential.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., operating as TriVest Wealth Counsel. The firm specializes in discretionary risk-managed portfolios, investment audit and oversight, and advanced tax, estate, and wealth planning. The opinions expressed in this article are not necessarily those of Wellington-Altus.