Barrons There used to be a column on the bond market called Current Yield that started in the 1970s when bonds really did have some yield. Now, nearly four decades after their peak – where risk-free long-term government bonds are above 15% – they offer no-return risk, as the column’s creator James Grant made famous.
In fact, when you factor in inflation, US Treasuries are yielding less than nothing. The real return on 10-year Treasury Inflation-Linked Securities (TIPS) is minus 0.84%, before offsetting future inflation. For a regular or nominal 10-year bond with a yield of 1.48%, the market effectively sets a “break-even” rate of 2.32% – this is the expected inflation rate at which investors are between TIPS and a nominal one Bond would break even.
So if bond yields rise from their all-time lows, their declines would overwhelm the meager interest rates they pay. This is the opposite of four decades ago, when high double-digit coupons would cushion the effects of falling bond prices.
In addition, bonds inevitably rallied during the long secular bull market that followed in stock prices, making fixed income the perfect hedge for a stock portfolio. This symbiotic relationship cannot be relied on if interest rates rise along with inflation in the future, making the traditional mix of 60% stocks and 40% portfolio less foolproof, as has been discussed several times in this column.
Given that Treasuries have no real yield and that riskier fixed income sectors like corporate bonds, mortgage-backed securities, and municipal bonds offer the smallest additional yield ever, Mark Grant comes to a similar conclusion to Jim (but no relationship). . The chief fixed income strategist at B. Riley Securities advises investors to sell their bonds entirely, regardless of whether they are looking at their absolute or relative value.
This includes bonds that are showing strong price gains and are now trading at high premiums because they were bought when the yields were significantly higher. These premiums will inevitably narrow once the bond matures at face value or, particularly in the case of Munis, is canceled prior to maturity at a small premium above face value. It’s better to sell and make a profit now, says Mark Grant. This is the case even though the investor owes capital gains taxes, he adds.
The question then would be where this money should be reinvested. The latest seven year forecast from GMO for different asset classes offers little encouragement to other investments. “By almost all standards we can think of – backwards or forward-looking – the valuations of US stocks are at a level that worries us,” comments Peter Chiappinelli of the GMO Asset Allocation Team.
These high current valuations result in annual real, inflation-adjusted returns of minus 7.8% for large US stocks and minus 8.4% for small US stocks. Only emerging market stocks appear to be posting positive annual real returns of 2.7%, which is less than half the historical real return of US stocks of 6.5%.
A nominal return of 9% would be required to achieve the historic real return on US stocks, assuming the Federal Reserve achieves its goal of keeping inflation modestly above its previous target of 2% for some time.
This is next to impossible in the current markets. The only investment near this high current income is closed-end funds, which Mark Grant recommended to institutional clients who have traditionally avoided the sector. However, he believes that some select CEFs are also suitable for retail investors looking for a high current income, such as retirees to pay bills or maintain their lifestyles.
Due to compliance restrictions, Grant is unable to name names, but is focused on CEFs and some exchange-traded funds, which are upward in double digits mainly due to their leverage. With the ability to borrow money at a lower interest rate and invest the proceeds at higher returns, leverage increases returns, but it also increases risk.
Some CEFs take a different route to generating ongoing income: a portfolio of dividend-bearing stocks. Some can use leverage to increase income while others sell options against their stocks and use the option premium to generate ongoing income.
We looked for examples of equity-based CEFs that trade at a discount to their net asset value and have ongoing returns in excess of 9%. Two of them are leveraged funds from Clough Capital Partners:
Clough Global Equity
(Ticker: GLQ), which closed on Thursday at a discount of 7.76% and a return of 10.84%, and
Clough Global Dividend & Income In
(GLV) with a discount of 6.99% and a return of 10.76%. The latter has a balanced portfolio of stocks and bonds, while the former is stock-based.
There are two such CEFs that use option writing
Voya Asia Pacific High Dividend Equity Income
(IAE), traded at a discount of 6.92% and a yield of 9.13%, and
John Hancock Secured Equity and Income
(HEQ), managed by Wellington Management, trades at a discount of 3.59% and a yield of 9.01%.
The main attractions of these Equity CEFs are Income, Income, and Income, in that order. You’re nowhere near that total 12 month return of 41.89% of the
SPDR S&P 500
ETF (SPY), after
Data. And they weren’t immune to passed out during the sharp sell-offs in the market in early 2020 when the pandemic hit.
But if you’re looking for income sorely lacking in bonds, these CEFs could play that role.
Write to Randall W. Forsyth at [email protected]