Two weeks ago, there was over $5 trillion invested globally in bonds priced with negative interest rates. Stated another way, people who bought these bonds are paying someone to use their money! At the same time, money market funds are yielding close to zero.

Mexico recently issued an interesting bond. The bond was denominated in Euros, had a 100 year maturity and a yield of 4%.   Do you see any problem with a Mexican bond that matures in 100 years! We think the person who created this bond is a genius.   Why? You get yield hungry Europeans to invest in your country for 100 years at a ridiculously low rate! As an investor, you must be drinking quite heavily to think this is a good investment. Does anyone honestly think that the Mexican government and the Euro will be here 100 years from now? Will you, as an investor, be alive in 100 years?

This investment has a significant amount of default and currency devaluation risk. We believe a 4% yield on a bond like this does not compensate investors for the risk they are taking. Nonetheless, this is the world we live in with zero interest rate policies all over the globe.

Over the past month, we have seen volatility pick up in the fixed income market. There have been many stories about the lack of liquidity in the market.   We asked an experienced high yield bond trader we have known for years if there is a liquidity problem in the fixed income markets? His answer was, “No, we don’t have a liquidity problem, we have a pricing problem.” He mentioned that there is liquidity, but it depends on the price you are willing to accept for the bond. In other words, to sell a position you may have to price a bond 3-5% less than the current price to find someone willing to buy it.   With below market value pricing, lack of demand and the possibility of an interest rate hike in the future, finding value in the fixed income market is much more challenging today than it has been in recent years.

What does this mean for portfolios?

This is certainly not a time to invest in longer-term bonds or have a significant amount in high-yield corporate bonds. Simply put, this is not the time to reach for yield. We believe that the fixed income market will continue to experience volatility for the remainder of this year as the Federal Reserve is no longer manipulating the market through quantitative easing. To combat this volatility, we have invested in an unconstrained bond fund. The fund’s investment approach, and one of its strengths, is that it benefits from increased volatility in the market. Other parts of the fixed income portfolio are invested in shorter-term bonds, master limited partnerships, closed-end funds selling at a discount to net asset value, and a non-traded REIT. Many people have not lived through a down market in bond prices and will be shocked to see a loss of principal as interest rates rise. We believe that any loss in bond values might be exacerbated by the pricing problem in the bond market.

Sincerely,

Your THOR Team