Looking For Yield In All The Wrong Places

June 16, 2020

“I would never buy debt at below zero.  Never, not at below zero…not in my entire life. I would do anything before I’d buy debt at negative rates.”

– Jamie Dimon, Address to Institute of International Finance, October 2019

Over the last several years, we have recognized what has been going on with negative or near negative interest rates in Japan, and is now bleeding into parts of Europe..  We never imagined that those troubles from afar would be any more than banter amongst economists and financial doomsdayers,. The reality of those environments have now made it to the shores of the good ol’ USA. 

Jamie Dimon, CEO of JP Morgan,  and other professional investors may not have to worry about buying debt below zero for the time being, but the way things are going, soon they might not have a choice. And regardless of politics, policy dictates that the US is going to be flirting with negative interest rates for some time to come.

Treasuries have gone from a modest but respectable coupon of 5-6% in the 1990s to now yields of under 2% and although look good compared to a negative rate environment, barely cover the cost of extra flavor in your double tall latte.

Dividends aren’t faring much better. Dividend cuts on the S&P 500 are adding up faster than any time since 2009. Royal Dutch Shell has cut its divided by 66% – its first cut since 1945, a full 75 years ago. For the first time in living memory, it looks as though the number of companies that aren’t paying dividends will outnumber those that are.

Corporate Debt has become a fallen-angel as many companies are on the verge of losing their investment grade ratings.  To borrower the famous expression about LTCM, investing in corporate debt looks a lot like. “picking up pennies in front of a steamroller”.

So when all the traditional watering holes for income have dried up, where do you go? 

Catch 55

Advisors throughout the country are wrestling with an internal conflict of how to best match up the retirement income needs of their clients with what may appear to be one of the best buying opportunities for appreciation in the last several years. Let’s call this, “Catch 55”.

The equity markets have recovered some from their highs in early March, availing several opportunities for mid-to-long term capital appreciation. But what do you do when investment horizons and income needs don’t align with market opportunities ? How do managers or advisors bridge a gap in market timing? 

Consider the Alternatives

The move away from the traditional asset allocation model to include a suite of alternatives for your clients has been proven to reduce volatility and provide risk adjusted returns uncorrelated to traditional equity markets. The assumptions of previous model, a combination of steady yields from treasury bonds and carefully selected stocks, seem almost quaint when set against the current reality.

In 2019, BlackRock acquired eFront ( an alternative investment software company) for $1.3B. Charles Schwab has partnered with iCapital Network and CAIS and J.P. Morgan has launched an investment trust dedicated solely to alternatives, all setting their sails for the importance that alternatives will play in portfolio construction for the foreseeable future. 

The long-term movement of these major institutional investors towards alternatives is just one part of a much bigger picture. As a result, wealth managers now find themselves at a juncture: They either introduce alternatives to their portfolio before the inevitable stampede consumes most of the value on offer, or they start thinking of how to explain sub-3% returns to retirement ready clients. Put that way, it doesn’t seem like such a complicated choice.