Out of the Box: Yield Hungry

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Yield Hungry

Now I deal, directly, with some of the largest money managers in the world and that gets my little gray cells going because these institutions employ some of the brighter people on the planet. They are also engaged in “winning” and I try my very best to help them succeed. I also have some individual clients, and I take that responsibility quite seriously. I carry that weight on my back 24/7 and that is exactly the way it should be, given my morals, values and ethics.

Now I have recently commented that we are in a “Borrower’s Paradise.” The other side of this reality is that we are in a “Fixed Income Disaster.” With the 10 year Treasury at 1.57% this morning, and the Fed scrambling to deal with our “Game of Thrones” battles with not only China, and the European Central Bank, but also between the Democrats and the Republicans, as we approach our next elections. In all cases, there are going to be both winners and losers.

The tensions in the markets are quite real now, and the volatility is heightened. One word from China, and new ECB pronouncement, or any unexpected political revelation, and off the markets go, especially the equity markets. We are in the thick of it and “Preservation of Capital” should remain at the top of your list.

Whether it is pension funds, insurance companies, banks, mortgage companies, Wall Street investment banks, retirees, seniors, or individuals trying to live off of their savings, all of these people, and institutions, are having issues. There is barely any yield in sight, or decent plans, by anyone, or any institution, to achieve it safely. “Grant’s Rules” remain in force, and I am afraid that our low yield environment is going to push many people, and some institutions, into making ever riskier bets to deal with our current environment. In the end, I am afraid, there may be many losing money propositions.

Consequently, today, I want to return to an article written by my esteemed friend at Barron’s, Randall Forsyth, which recently summarized the way that I achieve yield while being mindful of the “Preservation of Capital” rules.

“Playing the Coming Rate Cut With High-Yielding Closed-End Funds
But before Powell’s midweek trek to Capitol Hill, the daily Out of the Box missive from Mark Grant, chief global strategist for fixed income at B. Riley FBR, got more than its usual attention from his elite investor audience. Grant stated that, where bond vigilantes once ruled, central banks have become ‘The Force’ in the market…

And notwithstanding the ‘hype’ about independent central banks, he further argues, they are servants of the governments that created them. So they print money to lower borrowing costs to help fund budgets and social programs without the unpleasantness of taxes. Central bankers are the only people on earth who won’t go to jail for creating money.

Bond yields will stay low, owing to this ‘governmental intervention on a scale never before seen in history,’ Grant asserts. Decry this state of affairs, but all you can do is play along and try to front-run what the central banks will do next. The game is rigged, and has been since the financial crisis, he concludes…

Borrowers whose debts cost nothing, or less, may benefit, but savers, especially pension funds and endowments, suffer, he continues. They find it impossible to meet future obligations with negative-yielding bonds, especially when they assumed their assets would deliver annual returns of 7.5%. That will force their free money into risky assets, notably real estate and equities.

Such thoughts may not be unique or new, but few are willing to voice them out loud. And fewer of those expressing these opinions occupy the world of Wall Street, where fortunes are supposed to accrue to the best and the brightest…

Grant plays the game, both on defense and offense. (Because of compliance regulations, he can’t identify his picks.) For the defensive team, he sticks to five-to-10-year investment-grade corporate bonds. Not too exciting, but they yield about 4.25%. Grant buys individual bonds selling just below par, so investors can be assured of getting back their face value at maturity.

On offense, Grant favors an array of closed-end funds (again, he won’t name names) that yield north of 10% annually, with dividends that are paid monthly. Those payouts compound to increase returns significantly if reinvested, or provide regular income to investors who want it.

The high returns—and much of the risk—of these funds lie in their leverage. But the Fed has all but assured the markets that it will be lowering short-term rates, which would vastly reduce the risk of rising liability costs. Of course, the funds’ underlying assets could lose value in a bear market. And nobody scores double-digit yields without risk…

Grant aims for a return of about 7.5% from his strategy, split evenly between high-grade bonds on defense and double-digit yields from the closed-ends on offense. That would be roughly equivalent to the S&P 500 index, which just hit 3000, getting to 3500 in a couple of years. And it seems to be an easier way to play a rigged game.”

When logic and proportion
Have fallen sloppy dead
And the White Knight is talking backwards
And the Red Queen’s off with her head
Remember what the Dormouse said
Feed your head
Feed your head
-White Rabbit by The Jefferson Airplane

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
U.S. 954-468-2366
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