Bill Gross at His Best
John Mauldin, Editor
Outside the Box
- Duration is
unquestionably a risk in negative yielding markets. A minus 25 basis point
yield on a 5-year German Bund produces nothing but losses five years from
now. A 45 basis point yield on a 30-year JGB offers a current “carry” of
only 40 basis points per year for a near 30-year durational risk. That’s a
Sharpe ratio of .015 at best, and if interest rates move up by just 2
basis points, an investor loses her entire annual income. Even 10-year
U.S. Treasuries with a 125 basis point “carry” relative to current money
market rates represent similar durational headwinds. Maturity extension in
order to capture “carry” is hardly worth the risk.
- Similarly, credit risk
or credit “carry” offers little reward relative to potential losses.
Without getting too detailed, the advantage offered by holding a 5-year
investment grade corporate bond over the next 12 months is a mere 25 basis
points. The IG CDX credit curve offers a spread of 75 basis points for a
5-year commitment but its expected return over the next 12 months is only
25 basis points. An investor can only earn more if the forward credit
curve – much like the yield curve – is not realized.
- Volatility. Carry can be
earned by selling volatility in many areas. Any investment longer or less
creditworthy than a 90-day Treasury Bill sells volatility whether a
portfolio manager realizes it or not. Much like the “VIX®”, the
Treasury “Move Index” is at a near historic low, meaning there is little
to be gained by selling outright volatility or other forms in duration and
- Liquidity. Spreads for illiquid investments have tightened to historical lows. Liquidity can be measured in the Treasury market by spreads between “off the run” and “on the run” issues – a spread that is nearly nonexistent, meaning there is no “carry” associated with less liquid Treasury bonds. Similar evidence exists with corporate CDS compared to their less liquid cash counterparts. You can observe it as well in the “discounts” to NAV or Net Asset Value in closed-end funds. They are historically tight, indicating very little “carry” for assuming a relatively illiquid position.