The U.S. Federal Reserve cuts interest rates for the first time in more than a decade. Kim Parlee speaks with Greg Kocik, Managing Director at TD Asset Management, about how to build a high-yield portfolio in an era of low interest rates.
- Well, as we just heard, of course, the Fed has cut rates for the first time in 11 years. And my next guest says that could be a worrying sign, in some cases, for him, but that doesn't necessarily mean investors need to shy away for some of the riskier assets that are out there. Greg Kocik is the Managing Director at TD Asset Management, here to give us a primer on what happened and what he sees.
We just heard, of course, about the Fed cutting rates. And you look at this, I know, from a rate perspective, from a credit cycle perspective. So what does today's move mean from the credit cycle perspective?
- Well, looking at the last 10 years, we really did not have a normal, usual cycle. We really had, like, three different cycles. You could argue back in 2016 we came close to recession. So what we're seeing now is the Fed and other people are trying to see if we can actually prolong what really was a fairly shallow cycle, a somewhat disappointing economic cycle. And I think from--
KIM PARLEE: When you say disappointing, what do you mean? Based on what?
- Well, the GDP in the US has grown maybe around 22% over the last 22 years.
KIM PARLEE: That's a good number, is it not?
- It's not a bad number, but if you compare it back to the '90s, the similar sort of long period of expansion, the GDP in the US has grown by 40%.
KIM PARLEE: OK.
- So this is underperforming. It's not just the current US government or anything like that. It's just the way things worked out, much slower growth. And I think that if you see the Fed, you know, 10th year of a cycle, Fed cutting rates, is this something-- how can we understand it? Well, on one hand, it was a very slow recovery. There's still some time to go for the expansion.
On the other hand, you asked me about what am I worried about. And I'm worried about the bubbles, essentially, or distortions in the market already forming, basically as a result of these ultra low rates.
KIM PARLEE: And we see the distortions-- I mean, we can see-- people see it in real estate, in lots of different places. Will new bubbles pop up or is it just going to make the current bubbles bigger?
- I think new ones will pop up, or the ones we're already seeing are definitely going to get bigger.
KIM PARLEE: Yeah.
- So parts of real estate and government bond yields. We kind of got used to the fact that there are negative yields in Europe, and we just take it for granted. It's just the way they are. But today, Switzerland's 30-year bond hit a new low in terms of how low the negative yield can go for 30 years.
KIM PARLEE: What did it hit?
- This is about minus 16, 17 basis points for 30 years. So the lenders are basically giving money to the government of Switzerland for the next 30 years.
KIM PARLEE: To expect less back. Yeah.
- And even if you go to France, France is running a deficit of 3%, and it's got problems with some unrest in some parts of the country. And their 10-year yields are negative now. So this no longer makes any sense. It used to make sense when there was a crisis, you had to get out of the crisis. It doesn't really make sense anymore.
So again, it's not something that I would be concerned about in terms of pulling money out of the market. But there are some significant portions of the market that are quite distorted.
KIM PARLEE: Well, let's talk a bit about, then, what this means for you and how you choose what you invest in right now, because obviously distorted parts you probably want to stay pretty far away from. So how do you go about doing what you do in this environment?
- Well, we always started with the premise we can't forecast the turn of the cycle.
KIM PARLEE: Yeah.
- We spend a lot of time on figuring out where we are in a cycle and what will happen two, three years from now. But we are not going to be able to forecast the exact quarter, or even the year, frankly, when the cycle turns. So because of that, we're selecting investments on the premise that a cycle could turn tomorrow.
KIM PARLEE: Right.
- So any company we buy has to be able to sustain a fairly high amount of leverage that they typically have, in my space.
KIM PARLEE: This is the high yield space. I don't think we've declared this yet.
- This is the companies with more of a normal amount of debt.
KIM PARLEE: Yeah.
- Let's say three, four times debt to earnings. And those companies have to be able to manage that level of leverage for the whole cycle, even if it starts raining tomorrow, so to speak. And so it really-- you can find companies from cable, right from the stable cable industry all the way to very cyclical steel industry, that can fit into that paradigm. But we just have to make sure they are able to manage that debt load.
KIM PARLEE: I've only got about two minutes here, but I do think it's important. I know that you and I were talking earlier about statistics in terms of what the S&P has returned versus what high yield has returned over the last decade. And I think people would be surprised in terms of what high yield has returned compared to some of the other metrics around it.
- Yeah, I mean, the S&P for the last 10 years is up about 14% on a compounded basis. High yield is up 9.2%, so less than you would expect. After all, it is a bond instrument. But the volatility of the instruments, the standard deviation or volatility of high yield is significantly lower than equity. It's maybe 60% of what equity has done.
- So that's the last 10 years. If you look at last 20 years, though, if you go back to December of 1999-- I know it seems like ancient times ago-- the returns are quite different. The high yield is down almost 7% since then and S&P 500 only 6%, because the decade of 2000 to 2009, basically there was a 0% return for equities. So you can have-- over a long period of time, high yield can actually deliver close to equity returns with a lot less volatility. Because after all, you're buying bonds that the company has to repay.
So I think it's an attractive asset class, actually, going into the next two, three years. Not the whole thing, because there are distortions that companies are taking advantage of. So avoid some of those things. But if you're very selective, you can find either loans or high yield bonds that will deliver, in my mind, somewhere around 5% on your return. Not a lot, but it's much better than your 1.5% return from the government bonds.
KIM PARLEE: I've only got about 30 seconds here, and I know with-- in terms of key things you're watching, moving forward for this space, what will be a couple of things you kind of say, yeah, you gotta pay close attention to this one?
- Well, globally, China, what happens with China. I think we may be close to actually bottoming in China. But who knows? Maybe the tariffs make it even worse. Europe, what happens with Brexit and what happens with the slowdown that they have been experiencing? Because really, what the Fed is doing right now is reacting to Europe and China. Nothing bad is happening in the United States.
KIM PARLEE: Trying to pre-empt anything that could happen here.
- That's right. So just have to be quite careful on that front.