“The greatest issue facing fixed income investors today is the artificial zero percent interest rate, thrust upon them since 2008. This is essentially an experiment implemented by the Federal Reserve, one of epic proportion. In this report, LCM Capital Management provides income investors clear insight into the potential pitfalls and possible catastrophic consequences lurking below the surface in myriad bond mutual funds, and the many offshoots that are pushing the envelope of risk because of record low interest rates. The Federal Reserve’s policy has cost conservative investors…….. and forced trillions (of dollars) into much riskier asset classes.”
My partner and I wrote this article back in 2015 but the story began, as noted above, almost a decade prior. Fast forward to today, only a decade later, and the title stays the same. However, the script has flipped. Interest rates are at decade highs, the bond market appears to be struggling in spite of the words of Treasury Secretary Bessent to stay calm and my industry is still, and maybe even accelerating the at which it is, pushing clients into private REIT’s, private credit funds and other private investments portraying them as a diversified, attractive alternative once available only to Institutional or High Net Worth (HNW) clients but now available to them. Some in the industry have begun to even stop asking and are now at the point where they are just adding theses private products into your investments. For example, do you own mutual funds? You might say no, but if you have a company retirement plan, you almost certainly do. Do yourself a favor and look under the hood at what those funds really hold. Don't be surprised if you find a category simply called "other." If you do, ask your broker exactly what it is. I think they'll be hard pressed to give you an answer, and that alone should concern you.
You should also be aware of the trials and tribulations of Mark Walter, who’s better known for owning the LA Dodgers than he is for starting both Guggenheim Partners and the insurance company, Delaware Life.
It’s Delaware Life, however, that’s apropos to today’s interest rate environment. According to an article in the WSJ by Shane Shifflett and Matt Wirz* nearly 45%, up from 9% in 2014, or $42 billion of debt investments are in obscure private credit deals. According to the article, this is one of the biggest trends on Wall St. private credit firms gobbling up life insurance companies and using the premiums paid (by us, the policyholders) into high-interest private loans. I mean seriously, what could possibly go wrong here? As a result, the companies make the spread of the difference between the high interest rate loans and the low yield they pay to us, the policyholders. Sounds like a great deal to me, what about you Mr. Policyholder?
Mr. Walter is now under investigation and not for stacking the Dodgers lineup. Regulators require insurance companies to invest in investment grade debt - that way if something goes wrong, the belief is they will still have money to make good on their promise to pay death benefits or long-term care payments for your aging parents. What we are finding from the article is the insurers get around this investment grade issue by “creating complex investments that land investment grade ratings from credit-rating firms” Yes, I bolded that for a reason. For those of you old enough to remember the 2008 financial crisis and its causes, it’s deja vu all over again, and for those who don’t remember it, go to your Amazon Prime or Apple TV account and watch Michael Lewis’ “The Big Short”.
If you have been reading our past Benzinga articles (The Great Disclaimer, Hottest Party) then you know, we have been warning investors to tread very carefully when it comes to these lightly regulated, illiquid, high-cost private products.
Now back to the bond market and that ticking sound you hear. I’m fortunate or unfortunate to receive plenty of daily research emails, most of which are nonsense but a few lately have caught my attention since I love facts:
- 89% of college students now carry credit card debt
- Buy Now Pay Later (it use to be called a credit card) almost half (47%) of users made a late payment in the past year
- Debt Load Wallops Apartments ($300 billion of loans are maturing and will need to refinanced this year according WSJ)
All of the aforementioned headlines or stories are directly tied to interest rates and unless you’ve been living under a rock then you know, interest rates have been going higher and quite rapidly.
Now, if you’re wondering if my firm is calling for the sky to fall, the answer is no but it’s going to get volatile for sure. What we are saying however is, make sure that you know what you own, including what’s buried below the surface, and make sure you are diversified across stocks, bonds and cash and make sure you are invested towards your risk tolerance and not what someone tells you should be because of your age.
There is a better way.