How To Find Yield In Our ‘Borrower’s Paradise’

As the Chief Global Strategist, Fixed Income for my firm, I am often overwhelmed by the various tasks I am involved in daily. I spend a good bit of the early morning, I get up at about 3:30 A.M., seven days a week, just doing one thing, which is “thinking.” Playing the “Great Game” is not for sissies and you constantly have to have an “edge” to win. For me, personally, there is winning, and then there is everything else. The foundation of winning is correctly “figuring it out,” and that is what I spend a great deal of my time doing. I identify, you see, with one of my lifetime idols, a certain Mr. Holmes.

“My mind,” he said, “rebels at stagnation. Give me problems, give me work, give me the most abstruse cryptogram or the most intricate analysis, and I am in my own proper atmosphere. I can dispense then with artificial stimulants. But I abhor the dull routine of existence. I crave for mental exaltation. That is why I have chosen my own particular profession, or rather created it, for I am the only one in the world.”

– Sherlock Holmes

Now I deal directly with some of the largest money managers in the world and that revs me up 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.” With the 10 year Treasury at 1.77%, and the Fed scrambling to deal with our “Game of Thrones” battles with not only China, but the European Central Bank, there are both winners and losers. The borrowers are on top of it and fixed-income investors are at the bottom of it.

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 to achieve it safely. “Preservation of Capital” always rules 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:

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 an easier way to play a rigged game.”

So, there you have it. Thanks Randy. You are just the best!

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.