Charity investors that rely on the income generated by their assets are all too familiar with central bank stimulus. Even before the coronavirus crisis, attempts to support an economy that never quite recovered from the financial crisis of 2008 saw interest rates plumbing ever lower depths.
The result? “Safe” assets like government bonds could not offer the yields needed to meet spending requirements. Naturally risk-averse investors, including many charities, were forced into increasingly risky assets in search of income.
The “corona-crisis” has merely turbocharged this trend. Stimulus on a scale never seen in peacetime means that UK government bonds now yield barely 0.2%. Less than two years ago they paid nearly 2%, and on the eve of the last crisis they paid more than 5%.
Enter high yield corporate credit, sporting yields of 4-5% more than government bonds. For many incomestarved investors, these yields are proving irresistible.
Yet high yield is also known as “junk” for a reason: default risk is much higher than for “investment grade” credit, especially during a recession. Coronavirus shutdowns have triggered the worst recession since the Great Depression.
Correspondingly, yields – investors’ compensation for the risk of default – surged in March as markets sold off. Five months later, these yields are back down to pre-crisis levels. Why? Central bank stimulus. The promise of support and the lack of alternative sources of income have been enough to force investors back into the asset class.
Central bank liquidity can support prices, but it cannot fix solvency – the ability of businesses to pay their bills and debts longer-term. If the fallout in the real economy is anything like that of 2008, high yield investors face losses.
We also think that the same “helicopter money” which has helped credit markets recover since March is likely to drive us into a more inflationary era.
So, what are charity investors in need of income to do?
Adopt a total return approach to drawings – take some capital to supplement income rather than chase high-risk yield. Focus on protecting and growing your charity’s capital through a period in which yields are likely to remain low and inflation may pose an increasing threat.
Alexander Chartres is an investment director at Ruffer
Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.