Fed to Savers: Give up on Yield or Take on more Risk? -- Scott Colbourne
In April, 5-year U.S. Treasuries produced a negative real return of close to -1.5% after inflation. Negative real returns threaten bondholders and investors in fixed-income assets. I asked Scott Colbourne, who co-manages multiple fixed income funds at Sprott Asset Management LP, what to expect for fixed-income assets in the near future and how he is positioning his funds.
“The Fed’s policies distort the market by forcing investors away from bonds and into riskier market assets. They are not being fairly compensated for their money. We refer to the Fed’s current policies as ‘financial repression,’ because it appears to be rigged against savers. Federal bond-buying pushes down yields so investors in bonds receive lower returns. Changing definitions and regulations on liquidity force institutions to buy government bonds – further depressing yields. Meanwhile, investors’ purchasing power is declining over time as the Fed prints up new dollars to finance government debts.
“This means investors have to structure their portfolios –whether in fixed-income, equities, commodities, or precious metals -- with an eye on preserving their capital.”
Scott says that right now, very active management is required to navigate the short term in order to continue to generate real returns. “We are bearish on bonds in anticipation that interest rates will rise, but we are long the U.S. Dollar. We’ve benefited substantially from shorting Yen and emerging market currencies. Emerging markets are cutting interest rates, which is bearish for their currencies. Meanwhile, investors have dropped their emerging markets positions. There is evidence of stabilization in a variety of sectors in the U.S., providing an element of growth in an environment of low growth worldwide. So in the near term, the U.S. dollar is benefiting from weakness around the world.”
Slow worldwide growth has helped prop up the dollar says Scott, but bondholders still face the problem of ultra-low interest rates. “In periods of high inflation, government bonds are ‘certificates of confiscation,’ because the government is devaluing the currency at a faster rate than your rate of interest.”
So why continue to invest in fixed-income strategies? “How are you going to retire? How are you going to save? People will continue to require fixed income, especially for retirement accounts for people who hope to live off of the interest from their savings. But how are you going to live well as you get older when the Fed is either forcing you to take risks that you would not otherwise be comfortable with, or forcing you to accept interest rates that are guaranteed to make you poorer over time?”
Scott Colbourne joined Sprott Asset Management LP in March 2010. He co-manages the Sprott Diversified Yield Fund, the Sprott Absolute Return Income Fund, the Sprott Short-term Bond Fund, the Sprott Strategic Fixed Income Fund, and the Sprott Flatiron Yield Trust. He is a co-Chief Investment Officer at Sprott Asset Management LP.
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