Bonds Are a Broken Asset Class – It’s Time to Play a Different Game

By Steve Blumenthal

In years past, bonds provided attractive yields and served as a ballast for diversified portfolios. That game is over now. When you combine ultra-low yields with the Fed’s (the world’s de facto central bank) unabashed marriage to the US Treasury, the risk of inflation has rarely been greater. Rising inflation means rising interest rates––and that spells trouble for bonds. With that in mind, you need to play a different game. To that end, there’s good news.

First, let’s be clear: There is simply no way a 1.68 percent ten-year Treasury, nor 2.10 percent-yielding aggregate bond funds can help you. The last time we saw these levels was in the late 1930s. During the 1940s, ’50’s and ’60’s, bonds returned approximately 2 percent per year. Today, real (after inflation) returns are less than 0 percent.  If you rely on income from your investments to meet living expenses, zero real returns won’t work.  If you use bonds to balance the risks in your portfolio, zero won’t help either. So, what are some other options?

The Potential of Private Credit Opportunities

Consider short-term cash flowing private credit opportunities with maturities of five years or less. Some ideas include:

  • A portfolio of 300–500 cell tower, billboard, and data center leases with a cash flow of 6 percent; an approximate three-year maturity; and the potential for high single-digit returns after the lease portfolio is built, aggregated, and sold.
  • A well-collateralized first lean short-term construction lending fund that yields 6 percent with a two-year maturity.
  • A 7 percent-yielding fund, backed by pharmaceutical royalties. These are typically five-year term loans backed by royalties owned on biopharmaceutical products. The fund steps in and provides the loan with the collateral being the future royalty earnings stream. It’s an area in which few banks have the skill set to understand the collateralized asset; however, specialty lenders do. That creates opportunity––and a 5.75 percent-yielding corporate lending fund that uses a multi-manager approach to manage a portfolio of short-term corporate loans.

Regardless of the path you choose, conduct careful due diligence and in general avoid the use of leverage. The idea is to replace bonds yielding in the low single digits, not to swing for the fences.

The Benefit of Ladder Maturities

Higher inflation means higher costs on items we buy, and it also means higher interest rates. Laddering two-year, three-year, and five-year current cash flowing private credit opportunities offers an important benefit. Should rates rise, your portfolio resets at higher rates.  Expansion in government debt is funded by unprecedented money creation. The merger between the US Treasury and the Fed has occurred. What if inflation is not so “transitory?” Do you remember when we were told subprime is contained?  Should all the government spending turn to inflation, a laddering strategy provides the ability to roll maturing capital to higher yields in the future.

Combine Short-Term Private Credit with Actively Managed Trading Strategies

Another alternative to low-yielding traditional fixed income are actively managed trading strategies. The objective is to find skilled managers running trading strategies that have a risk/reward return profile similar to what bonds offered portfolios in years past when rates were higher. The goal is mid-to-high single-digit returns with limited downside loss during challenging periods. Many investors compare such managers to the stock market. In most instances, that is not the right comparison. They are a replacement to low yielding bonds. Diversification is important. Combining actively managed strategies with short-term private credit is a different game.

The bond market is broken. Rethink your approach. Play a different game.

Steve Blumenthal is a ForbesBook author of On My Radar: Navigating Stock Market Cycles, as well as the free weekly e-letter On My Radar.