Traditional fixed-income investments, in the form of bonds issued by governments and companies, are going through a very difficult period. Excessive borrowing by developed countries – and increasingly by emerging economies too – combined with central banks printing money at unprecedented levels, is making fixed-income investments generally less and less reliable. If we create money out of thin air without anchoring it to anything, debt becomes mere digits whose solvency is increasingly called into question, as income and the ability to generate cash flows to repay it become increasingly paltry compared to the amount owed. And this applies to both companies and governments in so-called developed countries.
If we also add to this a policy of interest rates at virtually zero that has been maintained for years, and central banks’ absurd asset repurchase schemes, the result is that even the most creditworthy (sic) debt – such as that of Germany or the United States – is subject to negative interest rates. Consequently, the debt of other countries – which are, paradoxically, heavily indebted – also enjoys minimal risk premiums; in other words, they pay an extraordinarily low cost for borrowing money.
This situation is completely unnatural, given that those most heavily in debt and insolvent should be paying much higher interest rates, and vice versa. But no. The manoeuvres of the central banks, in collusion with the rest of the private banks, and an increasing number of unsuspecting retail investors (not to say manipulated, given that banks are increasingly transferring more sovereign debt from their balance sheets to their clients’ portfolios), keep the yields on insolvent debt at almost zero.
We are therefore dealing with a fixed-income market (debt in the form of bond issues) exacerbated and artificially subsidised to pay the minimum interest (financial repression). Furthermore, against a backdrop in which the misnamed «risk-free asset» – the US Treasury bond – is set to stabilise in value over the coming quarters or half-years. This is because interest rates will begin to rise in the US at the same time as the Federal Reserve completely stops printing dollars – or, in other words, ends quantitative easing. This will mean that the Treasury will no longer be subsidised or bought back by the government, and consequently its price will fall, increasing its yield in line with the rise in interest rates. From that point onwards, the price of most debt issued worldwide will also fall, with risk premiums adjusting to the new yields offered by US Treasuries and the new official dollar interest rates.
All of this will result in a very significant reduction in the medium-term returns that fixed-income investors will receive. Even if the normalisation of the price/yield ratio for US sovereign debt occurs in a somewhat erratic manner, we may see large flows of money exiting many fixed-income issues in a turbulent fashion, as these large flows will only serve to amplify the corrections that the Treasury will undergo. It remains to be seen how German bonds and those of the rest of Europe will fare in such a scenario, as the ECB could continue its quantitative easing – if Germany allows it – and embark on a process opposite to that pursued by the US Federal Reserve, from which it is now backtracking. In short, these are turbulent times for most investors holding fixed-income assets in their portfolios, given that the tide which today washes away all shame, is probably on the verge of a disorderly exit.
This imminent scenario – which may last a few years until the debt has stabilised in terms of creditworthiness, stability and yields – has led us, for over a year now, to seek fixed-income alternatives that are stable, creditworthy and immune to the turbulent times ahead for the bond market. That’s no small matter. And we are convinced that the future of fixed-income investment still lies in lending in exchange for a fixed or variable interest rate, but one that is detached from the market prices and credit ratings that are so heavily manipulated these days. Let us say that, for the portion of our assets that cannot withstand the volatility of equities and require a shorter investment/divestment time horizon, we must focus on traditional lending to creditworthy borrowers, far removed from the growing turbulence of the bond market. However, as it is neither feasible nor advisable to lend large sums of money to a small circle of borrowers (just as it is not advisable to buy a single bond from any issuer), we must also do so through investment funds that analyse the creditworthiness and nature of these loans to companies and individuals.
In the field of corporate lending, there is a whole range of loan sizes, sectors, tenors and interest rates to choose from. It is a matter of selecting good fund managers specialising in this area who can analyse and select the best options. Some select companies with traditional commercial or industrial businesses, taking the company’s assets and the entrepreneur’s personal assets as collateral, and even taking temporary legal control of the bank accounts into which debtors’ sales revenue is paid, to guarantee repayment of the loan. Others select very specific businesses, such as those trading in goods worldwide, as in addition to the business collateral, we can also have the goods themselves as security, along with their letters of credit and recurring contracts, etc.
But bear in mind that the environment in which the companies we are going to lend to operate is also very important, as lending to business owners who have to battle against all odds in economies with rampant debt defaults and economic recession can be reckless. It is far more prudent to do so in countries with legal certainty and efficiency, and where economic growth – and therefore the solvency of their residents and businesses – is robust. In other words, avoid southern Europe, for example, barring exceptions such as a specific fund that limits itself to lending to Spanish companies that are net exporters to countries that do experience economic growth. Such cases are rare, but they do exist.
It is also time to capitalise on a property cycle that did indeed hit rock bottom (very rock bottom) almost two years ago and is now in the midst of a price recovery, with prices still much lower than in Spain. We are referring to the US property market. How can we capitalise on this upward cycle by lending in return for interest? Well, obviously by investing in the mortgage market. Yes, the very same market that collapsed seven years ago, only with the radical difference that mortgages are now held by much more creditworthy borrowers (personal credit ratings there are now stabilising after seven years) and whose underlying collateral (properties) is rising in value every year. And not just in the residential sector, but also in the commercial and office sectors. And yes, indeed, also through properly diversified mortgage funds managed by professionals who carefully select the mortgages in which they invest the fund’s money – that is, the investors’ money.
Ultimately, there is a vast universe of fixed-income investments, beyond the traditional issuance of bonds rated A, B or C by over-indebted issuers. We could call it Fixed Income 2.0 – a form of direct investment that has always been around, but which in recent months has been organised in a diversified manner, analysed and monitored through managed investment funds. This is a clear sign that money is increasingly flowing into this segment, gradually moving away from the manipulated, volatile and now highly uncertain traditional fixed income market. Will traditional fixed income—comprising sovereign and corporate bonds—ever become attractive again? Probably yes, but it faces a journey through the wilderness whose length and depth are highly uncertain. Because the central banks, with their endless balance sheet expansions, have placed us in hostile territory. And no one who claims to be serious can venture to guess when fixed-income markets will return to how they were, nor the volatility and defaults they will have to endure before they can once again become what they traditionally were: a safe haven for rentiers and for assets that need to be shielded from risk and volatility.