Eminent investor Howard Marks, in a follow-up memo to Sea Change, has urged investors to consider reallocating capital from equities to credit, highlighting that the era of ultra-low interest rates, prevailing from 2009 to 2021, might be coming to an end. He further emphasised that ‘investors today can get fetch equity-like returns from investments in credit’ as accommodative policies take a step back.
“In early 2022, high yield bonds (for example) yielded in the 4 percent range – not a very useful return. Today, they yield more than 8 percent, meaning these bonds have the potential to make a great contribution to portfolio results. The same is generally true across the entire spectrum of non-investment grade credit,” wrote Oaktree Capital’s co-founder.
Reiterating the journey from 2009 to the end of 2021, Marks said that the markets underwent two rescues of financial crises, aggressively accommodative central bank policies, lack of inflation worries, that led to generally uninterrupted investment gains.
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The declining discount rates coupled with associated reduction in competitiveness of bond returns, thus, proved to substantial asset appreciation. Asset ownership – be it related to companies, pieces of companies (equities), or properties – was the place to be, Marks noted.
However, a word of caution is warranted in current times, expressed Marks.
“In the new environment, earning exceptional returns will likely once again require skill in making bargain purchases and in control strategies, adding value to the assets owned,” he said.
Hence, the bottom-line in the current scenario is to increase substantial investment into credit as they are highly competitive versus historical returns on equities, exceed many investors’ required returns or actuarial assumptions, and are much less uncertain than equity returns.
Drawing an example from current times, Marks chalked out that the S&P 500 index returned just over 10 percent per year for almost a century, while these days the ICE BofA US High Yield Constrained index offered a yield of over 8.5 percent, and the CS Leveraged Loan index offered roughly 10 percent.
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Loosely translated, the expected pre-tax yields from non-investment grade debt instruments approach or nearly exceed the historical returns from equity.
Marks further suggested that by purchasing multi-year credit instruments, an investor can tie-up promised return for a meaningful period.
Though he refrained from saying that this was not a call for immediate defensiveness nor does he think that the stock market would collapse, but a reallocation of capital, away from ownership or leverage and toward lending could be fruitful from here on.
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