Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
In Focus: The Quest for Yield
The current momentum-driven and choppy market environment presents numerous challenges for investors – panic selling one day, panic buying the next. However, we’d like to take the opportunity today to address one market dynamic in particular, which is the quest for yield. This dynamic is more specific to what we are trying to achieve here at MWM.
Global monetary stimulus has forced an environment of negative real interest rates as the 10-year yield sits close to multi-year lows. This forces investors to go further out on the risk spectrum in order to achieve the same kinds of returns and expected income from portfolios. It poses a significant challenge for those who want to live from the income generated from their portfolios, as they are forced to either take additional risk or readjust their lifestyle expectations.
In the MAPS portfolios, two of the key areas in which we look to achieve yield in our portfolios are via specialty real estate and infrastructure. These areas are somewhat defensive in nature given that their cash flows are relatively stable regardless of economic conditions. Year to date, we have seen exceptional rallies in these areas, and many of the stocks under our coverage are up 25-40 percent or more. Without question, this poses a significant capital allocation challenge.
On one hand, our goal is to mitigate portfolio volatility and limit drawdowns. Despite what the academics tell us about “standard deviation” or, more simply, volatility being the be-all and end-all measure of risk, it’s just not so. Ever-escalating asset values result in greater risk in putting capital to work, not less. That’s because valuations become less attractive, not more so.
We are of course able to find yield in situations where we expose portfolios to balance-sheet risk and the ultimate ability to sustain dividends and/or economic cyclicality, where the company’s earnings and cash flows have greater economic sensitivity. In creating balanced portfolios, we require a combination of both to achieve the goals of enhancing portfolio yield while reducing volatility. This requires a great deal of discipline, as we would like to be fully allocated across all MAPS strategies as soon as possible. However, at the same time, we are very conscious of the real risk of the unwind of what has become a very crowded trade. In short, we are patiently impatient, and ultimately believe that the current environment is setting us up for much more compelling valuations in the future.
All that being said, we continue to pick away opportunistically at some of our core names as the short-term sector rotations have been somewhat violent. In particular, precious metals stocks have had a decent pullback off of recent highs over the last month. Warren Buffett famously said “when it is raining gold, reach for a bucket, not a thimble.” He meant that when stocks get cheap, you should commit capital. We would liken this recent sell-off in precious metals equities as more of a drizzle, and we think that a thimble is more appropriate in this instance as we accumulate positions for the long term. We are beginning to see financings pick up for junior companies in the precious metals area, which in the near-term is a good sign. At the same time, we recall that the last cycle brought about significant malinvestment as a direct result of too much capital chasing too few quality assets.
Natural resources, whether energy, mining, timber, or agriculture are, in general, pretty well beaten up. We see opportunities for incremental capital allocation in this area as well. However, since one of our primary stated goals is to manage risk and limit drawdowns in any given investment, we remain quite incremental in our approach.
As always, we greatly appreciate your continued support and interest.
Chief Executive Officer