- Howard Marks joked recently that investors should dump all stock and buy high-yield bonds.
- However, the Oaktree founder notes that "equity-like" returns are being seen in credit markets today.
It might be time for credit instruments to make up a much larger part of portfolios — maybe even the majority, billionaire Oaktree Capital founder Howard Marks wrote in his latest investor letter.
He said that speaking at a conference in December, he jokingly suggested that investors should sell every single kind of equity asset and use the proceeds to pounce on high-yield bonds.
"But mine wasn't a serious suggestion, more a statement designed to evoke discussion of the fact that, thanks to the changes over the last year and a half, investors today can get equity-like returns from investments in credit," Marks explained in the note.
In his letter in December of last year, Marks said that markets were in the midst of the latest "sea change," in which investors would be tested by upheavals in the investing landscape. He noted at the time that the roughly 2,000 basis point increase in rates between 1980 and 2020 was probably responsible for most of the investment profits in that era.
Now, he sees the return of higher interest rates and the end of the easy money era. It's a change that will make stocks lose their edge over bonds, and one that he says that means strategies that worked in the past aren't going to be as effective.
"Bottom line: If this really is a sea change – meaning the investment environment has been fundamentally altered – you shouldn't assume the investment strategies that have served you best since 2009 will do so in the years ahead."
While near-zero interest rates persisted from 2009-2021, not only were credit instruments largely unattractive, levered investing was a widespread strategy in stocks, as investors could juice returns with cheap borrowed money.
But the sharp uptick in interest rates above 5% has diminished that advantage, and headwinds for equities are piling up, Marks said. Those include a potential economic slowdown, eroding profit margins, higher default rates, less asset appreciation, and shareholder pessimism.
Meanwhile, bond yields have climbed, offering rates of return nearly on par with equities.
Where the S&P 500 has returned about 10% annually for the last century, the ICE BofA US High Yield Constrained Index now offers about the same.
"In other words, expected pre-tax yields from non-investment grade debt investments now approach or exceed the historical returns from equity," Marks said.
He adds that the other benefit of credit and fixed income is the fact that they are contractual investments, and rather than being at the mercy of the market, returns come from the contract between investor and borrower.
The ultra-low rates that followed the great financial crisis were an emergency measure that lasted too long, Marks said, and led to a number of economic inefficiencies. Lowering rates again would take away the Fed's ability to push rates down in case of future economic slowdowns.
Though the Oaktree note was originally published in May for Oaktree clients, Marks recently released it for a broader audience, saying that he has found that its message has only grown in relevance.
That seems to be true, as long-duration Treasury yields have climbed to highs not seen in nearly two decades, with the 10-year rate approaching 5% last week before pulling back in recent days.