Zero Interest Rate Environment: March Madness of a Different Sort
March 25, 2020 - Season 3, Episode 2
Advisory clients have portfolios designed to generate yield and weather storms like the one we are currently in. In this special report, Chris Abely will talk through the markets, risk, volatility and what’s driving the market.
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Scott Albraccio: Today, I want to bring you a special report on our advisory service platform.
Our advisory portfolios are designed to offset employee liabilities or pension benefits. Chris is going to talk to us today about how they are set up for just this type of situation. Yes, we've all seen dramatic losses in the market, as Chris will refer to in the podcast. The underlying factor is that the portfolios are still generating the yield, and that's what they were designed to do. The holdings in these portfolios are blue-chip named companies, are not going anywhere, and they continue to pay us good yield.
Chris Abely, CFA:
In our advisory portfolios, those are dedicated portfolios based around a given objective, be it for pre-funding of expenses or be it for pre-funding of pension assets and pension plans. Oftentimes, when you're involved with those types of facilities or portfolios, there is dedicated asset allocation, be it fixed income, preferred stock, real estate investment trusts, master limited partnerships, be it well-capitalized, blue-chip securities, with dividend and yield and strong balance sheets. In the environment we've been in, as we spoke about over the summer of last year, and I've written down in many places that we thought we were going to head back down to zero interest rates.
Well, it looks like that's where we're headed. Now, the zero interest rates may actually be a component of and be part of the virus and it's causing it to accelerate to a zero interest rate. But in the long run, we still thought that the federal reserve would have to bring interest rates down close to zero again, because the demand for money is much less than people had hoped for, and there's really no inflation in the system.
People have often asked us about why there's no inflation in the system, and I think it's as simple as this. There's too much supply of everything. Walk out your front door and look at all of the different things that compete with one another: convenience stores, four of them on each corner, gas stations, restaurants, Amazon, Walmart.
You go down through the list and realize that everything has competitive pricing. Everything has an alternative in case you want to buy it. So, the idea that we'd get price inflation in goods doesn't seem to be warranted simply by we've got an oversupply of everything. Everybody might have heard the term supply-side economics. Well, supply-side economics has come to roost, and it's come to roost right on interest rates. What have we been doing as a consequence of that? We've been trying to build rational portfolios that build out a yield that can be considered conservative but still be appropriate.
Chris Abely, CFA:
Now, with the virus having hit and the Black Swan event of not only the virus but also the issue between Saudi Arabia and Russia in oil, we basically had two things collide. Those two things have caused a depreciation in the price of oil and has affected some of the master limited partnerships and has also affected some of the yielding oil stocks. That being said, the chances of this being a prolonged war on oil probably only last until the election if it even lasts that long. And therefore when it recovers, most of these assets should recover. In the meantime, they continue to pay us a yield.
But here again, when you talk about assets and you talk about a diversified portfolio, that's usually associated with normal times. When you have these event risks occur, those correlations tend to all get exaggerated and move in the same direction. So, this week, and we're sitting here and it's March 12th, 2020 and the president has just decided we're no longer flying to Europe for the next 30 days. This week, the long bond fell in value while stocks fell in value, while gold fell in value, while master limited partnerships fell in value, while REITs fell in value, and the only thing that seemed to hold up in value was cash. And everybody knows that cash is not a way to invest in the long run.
It can be used or should be used strictly for opportunities and for liquidity purposes. So, we continue to stay very focused on our advisory platform and continue to build out the preferred stock element of it because those are one of the things that have held up very, very nicely in this marketplace. And we think that that will continue to hold up.
Buying yield or getting yield will be something that all financial institutions have to be very concerned about because as interest rates go down towards the zero band, there's not a lot of spread. So, when there's opportunities to build a portfolio that will help offset some of the costs associated with pre-funding into conservative portfolios that will yield significantly higher than zero, and after all, significantly higher than zero if it's 3 or 4% is significant, but you can probably even consider a little bit higher with a little bit more risk, that those portfolios are readily buildable and readily available.
Chris Abely, CFA:
So, again, to our advisory clients, we do think that the shock will continue, but that the assets that are underlying the portfolios, and it's very important here to understand that they're assets underlying the portfolios. Oftentimes, you'll hear people talk about stocks, as opposed to companies. Well, when you think about it in terms of companies, you look at it differently than if you think about it in terms of stocks, that is, "Will my stock recover?" Or, "Oh, that company is a solid company." Johnson and Johnson? Johnson and Johnson will be around for many, many, many, many more years. So will feel like some McDonald's. And Exxon Mobil, contrary to popular belief, is not going away. They have a solid balance sheet. They have great assets. They've been through this before.
Thank you for listening to our podcast. I hope you found that informative. Don't forget to subscribe to our channel and never miss an episode.