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This Credit Manager Says Long Bonds Are Going to Sabotage Investors

Mariner Investment Group says investors should take half their bond portfolio and put it in alternative credit.

With interest rates at lows for a decade, experts have warned of the risks of holding government and corporate bonds, which are designed to provide stability for a portfolio. Now, as the Federal Reserve signals that it’s comfortable with a long period of low rates and rising inflation, Mariner Investment Group is turning up the volume on its alerts.

“The potential downside is massive for traditional fixed income,” said William Michaelcheck, co-chief investment officer of Mariner, in an interview with Institutional Investor. “If you were a Martian who had just landed on earth and had $100 to invest, you wouldn’t even consider putting it in fixed income now.” 

Michaelcheck said investors should consider putting a much bigger chunk of their fixed-income portfolios into alternative credit. Although Mariner, an alternative credit manager, stands to gain if investors make the move, the manager’s funds would be only one piece of any alternative credit portfolio. Unlike traditional fixed income, where one manager can potentially oversee huge mandates, alternative credit managers typically oversee smaller amounts of money. 

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In a letter to investors obtained by II, Mariner argued that many investors haven’t fully thought through the risks of owning government and corporate bonds in a market environment like the current one. It goes well beyond earning paltry yields. The credit firm said that structural factors are leading to rate pressure and that CIOs, chief risk officers, and trustees should think hard about duration risk and the risk-reward profile of traditional fixed income.

“We’re positing that investors shouldn’t own long-duration bonds,” said Edward “EG” Fisher, Mariner’s other co-CIO. “So put half of the fixed income allocation in super short-term instruments. With the other half, find an alternatives platform that can generate alpha and that won’t necessarily lose money if rates go up because the manager doesn’t have a long duration bias.” 

The markets are undergoing a massive shift, including a dramatic increase in both government and corporate bond issuance that Mariner described as “perhaps the biggest structural change in the history of Treasury issuance.” Other factors that are leading to rate pressure are the Fed’s resistance to negative interest rates and the U.S. central bank’s expressed policy of enduring a period of inflation before raising rates. The policy is a very different stance than the Fed has had historically. 

Even if institutions understand the risks, it’s not a slam dunk decision to change course. 

“Just because you read about it in college doesn’t mean you have to own it forever. But what do you do with that money?” said Michaelcheck. “You can’t put it into cash or increase your exposure to stocks because that is too risky. You should own more alternatives. However, it’s much harder to manage a portfolio of alternatives products than it is to just buy nice investment-grade bonds. People buy investment-grade credit believing that will allow them to sleep at night. But our point is ‘no, you can’t sleep at night with that in your portfolio.’”

He recently advised an endowment to take half of their 40 percent allocation to fixed income and put it into one-year paper that will earn 0.25 to 0.5 percent. With the other 20 percent, he told the endowment to find a portfolio of 8 to 10 alternatives funds that are diversified from each other and aren’t correlated to either the stock market or to interest rates.

Pensions and endowments may have to rethink the standard advice of allocating 60 percent of a portfolio to stocks and 40 percent to bonds, according to Michealcheck.

“Two hundred years ago, endowments thought owning stocks would be imprudent and everything was in bonds,” he said. “Conventional wisdom hasn’t always been 60-40. In the future, someone could question how an endowment could own long duration bonds!”

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