Beyond Stocks: The Allure and Strategy of Credit Investments
Oct 18, 2023
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Exploring the impact of Howard Marks on investing strategy, analyzing default rates for non-investment grade bonds and bank loans, allocation of risky assets, advantages and types of preferred stocks, strategies for investing in credit instruments, the allure and risks of credit investments, and the intricacies of closed-end funds.
29:48
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Quick takeaways
Investing in non-investment grade bonds, leveraged loans, and preferred stocks can be more compelling than investing in common stocks.
Understanding the contractual agreements and attributes of preferred equity can give them an advantage over common stocks.
Deep dives
The Allure and Strategy of Credit Investments
In this podcast episode, the host explores the allure and strategy of credit investments. He highlights the importance of understanding investment conditions, expected returns, valuations, and yields on bonds and other credit instruments. The discussion focuses on three types of credit instruments: non-investment grade bonds, leverage loans, and preferred stock. The host emphasizes the contractual nature of credit instruments, where returns are primarily driven by contractual agreements between investors and borrowers. He discusses the potential risks and rewards of investing in these instruments, including default rates, recovery rates, and historical performance. The episode also explores different ways to invest in credit instruments, such as through passive index funds, actively managed funds, individual securities, or closed-end funds.
Determining Allocation to Riskier Assets
The host explains the concept of the Merton share, a formula that helps determine the percentage of net worth to allocate to riskier assets. The Merton share depends on factors such as expected returns, expected risk, and risk aversion. The episode discusses the role of risk-free rates in determining the allocation to riskier assets, highlighting that higher risk-free rates may lead to lower allocations. The host also mentions Howard Marks' recommendation to sell stocks and invest in high-yield bonds with attractive yields. The discussion includes the potential benefits of high-yield bonds, such as comparable historical returns to stocks but with lower volatility. However, the host cautions about the importance of considering economic conditions, spreads, and potential recessions when investing in high-yield bonds.
Investing in Credit Instruments
The episode provides insights into different ways to invest in credit instruments. It discusses passive and active approaches, as well as individual security purchases and closed-end funds. The host mentions popular ETFs and mutual funds for passive index investing in high-yield bonds, leverage loans, and preferred stocks. He emphasizes the need to conduct credit research or rely on professionals when investing in credit instruments. The episode also touches on the risks associated with credit instruments, including default rates, dividend suspensions for preferred stocks, and market volatility. The host shares his own portfolio allocation of approximately 7% in high-yield bonds and bank loans, and around 6% in preferred stocks, highlighting the need for incremental changes and cautious investment strategies in these areas.
Why investing in non-investment grade bonds, leveraged loans, and preferred stocks is potentially more compelling than investing in common stocks at present.
Topics covered include:
Why Howard Marks told institutional clients to sell stocks and buy high-yield bonds instead
The contractual agreements comprising bonds, leveraged loans, and preferred stock give them an advantage relative to common stocks
How preferred equity exhibits attributes of both bonds and common stocks
What is the expected return and risks for high-yield bonds, leveraged loans, and preferred stock
