Looks like the investoriates are running out of high-reward/low-risk wagers, and must consider further 'diversification' as the flood of money pinned much to the high-watermark
tulips or bitcoins, modern art or silver
time closer to picking poisons
bloomberg.com
The 40 in 60/40 Portfolios Is Getting Wilder and Wilder
Sally Bakewell
24 October 2020, 21:00 GMT+8
Record-low yields make conventional formula untenable for many
Some seeking more esoteric types of debt to meet obligations
It probably sounds crazy to talk about a crisis facing American investors right now. The stock market is still white hot, and bonds have barely lost a beat after surging earlier this year.
Yet dig a little deeper and you’ll notice not all is as it seems.
For one, sky-high debt prices have made it more difficult to hedge against losses should the relentless rally in equities hit a bump in the road. But more importantly, rock-bottom yields are making it harder than ever for pensions, endowments and other money managers to hit the targets they need to meet their long-term obligations.
“The massive rally in all asset prices is destroying their potential to provide investors a return comparable to those they have gotten used to in recent decades,” JPMorgan Chase & Co. strategists led by Stephen Dulake wrote in a report last month.
It’s forcing adherents of the classic investing strategy of 60% stocks and 40% bonds to look further afield as they seek returns even remotely close to the near 10% annualized gains they’ve enjoyed since the 1980s. In fact, without revamping their portfolios, JPMorgan predicts U.S. investors will barely reach 3% per year over the next decade -- part of what it calls a new “returns crisis.”
Read more: The death of 60/40 has been somewhat exaggerated
For fund managers counting on earning at least twice that, it means shifting fixed-income allocations to assets once considered on the fringes of conventional investing -- things like whole-business securitizations, entertainment royalties and catastrophe bonds.
While the potential payout is greater, the trend also underscores the significant risks that have accompanied the Federal Reserve’s unprecedented efforts to shore up the economy in the wake of the coronavirus pandemic.
Here’s where some of the top names in the business are turning as they seek to navigate an increasingly difficult investment environment in the years ahead.
Whole-Business Securitizations
While banks heralding the death of the 60/40 portfolio is nothing new, the sheer scarcity of yield this time around is. That’s prompting some investors to seek higher payouts via more esoteric asset-backed structures.
Whole-business bonds are dominated by well-known restaurant chains, which mortgage virtually all their assets -- from franchise fees to license agreements -- as part of the financing. While they can pay anywhere from 2.5% to 7.5% depending on where they rank in the capital structure, some deals were flaggedas particularly risky by rating companies early in the pandemic as Americans shied away from indoor dining.
But Nuveen Asset Management, the investing arm of the Teachers Insurance & Annuity Association of America, is among buyers of the securities, according to Tony Rodriguez, its head of fixed-income strategy. He favors restaurants getting more than 70% of their revenue from food consumed off premises -- which have fared better in the wake of the pandemic -- such as Domino’s Pizza Inc. and Dunkin’ Brands Group Inc.
“We think there’s a reasonable trade off to be made from moving away from a focus on that 40%, to a more broadly diversified portfolio,” Rodriguez said. “We often say if you want to trade government debt, dial 1-800-NO-YIELD.”
Entertainment Royalties
Remember Bowie bonds? They were asset-backed securities sold by musician David Bowie in 1997 that were tied to future royalties from his hits. Securities backed by royalty streams from music to pharmaceuticals have made their way into Cambridge Associates portfolios, according to Chief Investment Strategist Celia Dallas.
“These are on the higher end of the risk-reward spectrum of diversifying strategies,” Dallas said, adding that it’s “generally a matter of when, not if, you are paid, with any losses well underwritten by good managers.”
Single-Family Rentals
As Covid-19 spread across the U.S., many would-be home buyers became less willing or able to take on mortgage obligations, while a shift toward working from home prompted some to exchange city living for suburban family houses, boosting demand.
Securitizations backed by groups of thousands of single-family rental homes tend to pay in the 2% to 5% range, depending on where they rank in the payment priority pecking order.
Pretium is one of the largest issuers of single-family rental securitizations, and the largest private owner and operator of single-family rental homes in America.
“As we talk to clients around the world, from Abu Dhabi to Seoul, there’s an overwhelming demand for alternative fixed income,” said Don Mullen, founder of the $16 billion firm, which recently won a mandate from the manager of Air Canada’s pension plans. “It’s gone from alternative to mainstream alternative.”
Preferred Equity
Preferred stock is a special type of security that sits below all of a company’s debt in the right of repayment in case of a bankruptcy, but at the top of the equity stack. That greater risk relative to the debt means a higher yield, which comes in the form of recurring dividend payments.
That’s why GW&K Investment Management’s main portfolios are now allocated up to 5% in fixed-to-floating rate preferred stock, up from next to nothing this time last year, according to Stephen Repoff, a money manager at the firm.
Preferred equity started gaining traction after the 2008 financial crisis, when some of the biggest U.S. banks began to issue a special version of the securities because it helped them meet regulatory requirements and create a cushion for losses.
Repoff recently bought Goldman Sachs Group Inc.’s 4.4% preferred stock, which trades at a discount to par. The stock never matures unless the bank decides to call it, but the interest rate will reset once every five years starting in 2025.
“If you’re purely yield-focused and relatively insensitive to mark-to-market volatility, this is a really nice asset class,” Repoff said.
Reinsurance
Cambridge Associates is also boosting purchases of insurance-linked investments, such as more liquid catastrophe bonds. The securities are a type of risk-transfer mechanism, where investors receive high coupons, frequently exceeding 10%, but run the risk of losing all or part of the bond’s face value if a certain type of disaster, such as a hurricane, hits.
“Cat bonds have higher yields than high-yield bonds or syndicated loans, and with corporate insolvency risk still elevated with Covid uncertainty, expected losses can also appear more favorable for cat bonds, at least in historic terms,” Dallas said.
Private Debt
Some investors are also turning to private debt, which ranges from middle-market lending to direct loans for larger companies. The assets yield more -- in the five-years through March 2019, direct lending funds saw average annual returns of just under 7% -- because of their illiquidity and the risk that comes with lending to smaller firms.
Even though private debt fundraising has been squeezed amid the recent volatility, buyers still see value in the trade-off: Investors looking to commit more capital to the asset class rose to 48% in June, up from 39% a year ago, according to a Preqin survey.
The California State Teachers’ Retirement System recently allocated $1 billion to direct lender Owl Rock Capital Partners.
— With assistance by Kelsey Butler, Noel Hebert, and Dan Wilchins
Before it's here, it's on the Bloomberg Terminal.
LEARN MORE |
