ROCK-BOTTOM interest rates present investors with a stark and difficult choice of income or safety, says Oaktree Capital Management chairman Howard Marks.
The dilemma, he says, is that while investors may prefer the stability of fixed-income investments, they are being pushed up the risk curve by very low yields.
"Their scramble for return has brought elements of pre-crisis behaviour very much back to life," Mr Marks says in his latest commentary, "Ditto", published in January.
In a recent visit to Singapore, he says he is "rather pro-stocks". "Stocks are less overpriced than bonds ... they're attractive relative to bonds." But even that statement, he adds, obscures the vastly differing nature of risk that an equity investor takes on compared with a bond investor. In the event of bankruptcy, bondholders get priority in terms of liquidation proceeds, and stockholders get only what is left over after creditors have been paid.
'I don't believe there is an analytically sound way to invest in gold. You can do it out of fear, superstition or the assumption that gold will continue to function as it has, but you can't tell me why it should. It's not intellectually sound, although that doesn't mean it is not going to work.'
Mr Marks
"Today, three-year Treasuries pay half a per cent before fees. Many can't live with that so people buy high-yield bonds to get returns lower than what they used to get on intermediate Treasuries," he says.
The "normal" offered yield on high-yield bonds is in the low double digits, he says. "Today you see bonds at 5.5 per cent. I refer in my column to bonds with yields of 3 or 4 per cent and it's not very appetising. But the trouble with investing is if I say it's not absolutely attractive, what else will you do with your money? You may say it's terrible but everything else is worse."
Strategists and fund managers are concerned today that after an extended 30-year bull market in bonds, any upward movement in interest rates will spell substantial losses. Some, however, believe that the sheer weight of money in search of yield will underpin corporate bonds.
Mr Marks, who himself has been investing in fixed-income securities for some 35 years, says people are "handcuffed volunteers" at the moment, "doing things not necessarily because they want to, but because they have to". "There are people buying high-yield bonds today getting 5.5 per cent who wouldn't buy them 10 years ago to get 12 per cent."
Investors should at least go in with their eyes open. "If you are going to take on extra risk, then - number one - you should do it consciously, knowingly. Two, you should do it carefully. When you're on uncertain ground, our mantra is to move forward but with caution."
He says investors should adjust their expectations of returns from high-yield bonds downwards. The asset class was a star performer last year with returns of about 15 per cent. "The one thing I can tell you with absolute certainty is that you won't get 15 per cent (return) out of 7 per cent bonds for long."
High-yield bonds
Still, relative to Treasuries, high-yield bonds are "overwhelmingly likely" to outperform. A scenario where the investor loses the entire spread of 4.5 per cent suggests a default rate of 7 per cent. "To lose the whole spread, you'd have to have the worst credit outcome in history, which is not highly likely."
As at end-2012, Oaktree Capital reported assets under management of about US$77 billion (S$95 billion), mostly in corporate and distressed debt, as well as convertible securities.
Mr Marks is sceptical about gold as it pays no income and, therefore, is difficult to value. "I don't believe there is an analytically sound way to invest in gold. You can do it out of fear, superstition or the assumption that gold will continue to function as it has, but you can't tell me why it should. It's not intellectually sound, although that doesn't mean it is not going to work."
The efficacy of an investment decision relates to the price you pay, he says. "But I don't think there is any way to figure out if today's gold price is fair, too high or low ... When you have an asset with no income, you can't really soundly discuss the right price."
In his column "Ditto", he refers to indications in the credit world of an "elevated, risk-prone market". The volume of new issue leveraged finance - loans and high-yield bonds - for example, reached US$812 billion, surpassing by 20 per cent the previous record set in pre-crisis 2007.
"Yield spreads or credit risk premiums are fair to full - meaning the relative returns on riskier securities are attractive - but the absolute returns are minimal."
The ability to execute aggressive transactions indicates risk tolerance. "Triple C bonds can be issued readily. Companies can borrow for the purpose of paying dividends to their shareholders. And CLOs (collateralised loan obligations) are again being formed to buy leveraged loans with heavy leverage," he said.
