Advertisement
investing

Go Ahead, Reach for Yield

The best bets are in arcane areas such as commercial mortgage-backed securities, nonbank business lending and structured credit.

With bank rates and bond yields collapsing again, investors are embracing unconventional income securities priced to yield 6%, 8% or even 10%. Yes, spreads between Treasury yields and the yields you get from many such investments—including high-paying partnerships, closed-end funds, mortgage real estate investment trusts, specialty lenders and business holding companies—look dangerously wide, oftentimes six or eight percentage points. In theory, such a big gap implies that a recession is in the offing and will send investors running to higher-quality assets, or even cash. High-yield investments of all kinds got slammed in 2008.

But I often dissent from the orthodox view. I believe that 2019's sinking Treasury yields, which magnify the spreads on everything else, are not a sign of economic peril. Rather, Treasury rates are puny due to the timid Federal Reserve and the $15 trillion of foreign government debt that carries negative yields. U.S. bonds have transitioned from being reserves for domestic banks and insurers and a haven for everyday savers to being the world's lockbox, a global repository where anyone can hold almighty U.S. dollars and earn a positive yield.

Advertisement - Article continues below

New ways to measure risk. Because Treasury debt is caught in these disruptive, rule-breaking financial times, investment pros have become open to other ways of weighing investments besides the yield spread over T-bonds. Creditworthiness and business prospects take top billing. Those can be tough for you and me to pin down, and ratings agencies can get them wrong—but the new approach produces trading and investment opportunities. "Just because something yields 8% doesn't mean it is high risk," says Christopher Zook, CEO of CAZ Investments.

Advertisement
Advertisement - Article continues below

Zook says that sound borrowers are paying seven percentage points above three-month cash rates to short-term lenders and private loan pools, because big banks are de-emphasizing traditional handshake corporate lending.

How can ordinary investors get in on these deals? The best ideas are in arcane areas such as commercial mortgage-backed securities, nonbank business lending and "structured credit," which packages loans, mortgages and receivables into interest-bearing securities backed by those assets. The point is that these borrowers aren't in trouble. They voluntarily pay up to borrow, and then the market's recession fears plump up yields by another full point or two. Before investing, I do insist that you scour disclosures to look mainly for secured credit and avoid dealings in oil and gas and emerging markets. A multi-industry, consumer-focused, U.S.-centric strategy is best. The following are essentially investment or holding companies, with portfolios of loans or businesses. But their stocks trade like any other.

Advertisement - Article continues below

Apollo Investment (symbol AINV, $16, yield 11.2%) shares have returned 41% this year, although they still trade at a discount to the per-share value of Apollo's portfolio of debt securities. (Prices and other data are as of September 30.) Apollo's loans and airplane leases are mostly secured, and almost all are floating-rate. Its rival lender Ares Capital (ARCC, $19, 8.6%) has a 28% return so far in 2019 and has virtually eliminated subordinated debt (which ranks behind other debt in the event of default) from its portfolio because Ares can still collect an overall 10.5% on better-quality assets. The shares trade a tad above the $17.27 per-share net asset value of Ares' underlying holdings—but that's acceptable. Compass Diversified Holdings (CODI, $20, 7.3%) owns businesses rather than lending to them and is up 69% for the year to date. Yet its yield remains robust, and it trades close to its net asset value.

In a future column, I'll talk about debt pools of much shorter duration that yield about 4% and are suitable substitutes for ultra-short debt funds or cash.

Advertisement
Advertisement

Most Popular

18 Things You Can't Return to Amazon
Smart Buying

18 Things You Can't Return to Amazon

Before tossing these items into your virtual shopping cart, be sure to read Amazon's return policy first.
September 17, 2020
Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020
7 Foreign Countries Luring Americans to Work Abroad During the Pandemic
careers

7 Foreign Countries Luring Americans to Work Abroad During the Pandemic

Work remotely – really remotely – in these appealing destinations offering special visas for American workers.
September 18, 2020

Recommended

Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
Best Bond Funds for Every Need
Investing for Income

Best Bond Funds for Every Need

In a changing market, it’s important to remember why we hold bonds in the first place.
September 15, 2020
Does a 40% Bond Allocation Make Sense in Today’s Portfolios?
retirement planning

Does a 40% Bond Allocation Make Sense in Today’s Portfolios?

For many investors, the short answer is no. Here’s why, and what you might consider instead.
September 7, 2020
Is the Stock Market Closed on Labor Day?
Markets

Is the Stock Market Closed on Labor Day?

The good news: Stock markets and bond markets alike get the day off for Labor Day. But traders don't get an early start to the weekend.
September 5, 2020