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Yield Investors: What You're Looking For Isn't There

Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Chris Goolgasian. He is the head of portfolio management of the investment solutions group at State Street Global Advisors.

Chris, thanks for joining me.

Chris Goolgasian: Thanks, Jeremy. I appreciate it.

Glaser: Let's start with looking for income. You obviously manage a fund that's out there looking for income, that's allocating to different ways of finding it. Investors have been searching high and low for it. Are there any places left, any stones that haven't been overturned?

Goolgasian: That's a good question. I think the old line "comparison is the death of happiness" is a great way to describe the landscape that investors find themselves in today. I feel like investors think that there's something they don't know about, and they are just searching to find out about it. It's like they think there is a big secret, but there isn't. Everything is unattractive in the yield space. And it's a relative world where you have to find the ones that are slightly more attractive in a space that, in general, is not attractive.

I think if investors can embrace that idea, they can avoid some of what I've termed "the optimistic unknown," which is searching and being optimistic for higher-yielding product that's really unknown to them and how it's constructed and how it works. That's a recipe for disaster.

Glaser: So, what does look more attractive on a relative basis?

Goolgasian: For our income-slanted portfolios, we've been significantly overweight in dividend-paying equities, which on a number of metrics are significantly more attractive than the entire fixed-income landscape. Now, within fixed income, we've preferred credit over Treasuries. The spreads have certainly tightened and are no longer as attractive as they have been; but still, there's a little something there.

We've also preferred something that most of the marketplace really does not like, and that's the long end of the curve. And the long end of the curve is a great diversifier to holding dividend-paying equities. So, it helps to reduce volatility. In a year like this, long end also has an added benefit having had a really good run. But the marketplace is generally short duration. People think rates are going to rise and they are going to rise quickly, and people have had no appetite for the long end of the curve. Everyone wants to move shorter on this big worry about interest-rate increases, and certainly that is going to happen someday. We're not so sure it's going to happen imminently. But in the meantime, you get much more carry on the long end, and from a diversification standpoint, it is a terrific diversifier to holding this extra equity because the long bond is a great risk reducer to that equity position.

Glaser: On the other hand, what doesn't look very attractive right now?

Goolgasian: So, we've been underweight in high-yield, and our perspective is, on a risk basis, we certainly prefer dividend-paying equity over high yield. Equities are reasonably valued, and we think high-yield is overvalued. And generally, high yield tends to act like equities, especially in riskier markets. And on the equity side, you have the potential for innovation and growth and a yield that is also, at times, pretty healthy, too.

Now, you have high yield with a spread that is extremely low, absolute yields that are very low--very little upside--and of course, being a fixed-income instrument, no ability to innovate, grow and all of that. So, within our tactical positions, we've been underweight in high yield and overweight in the dividend payers.

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Glaser: Let's turn our attention to inflation. We had maybe a little bit of a scare in spring; things are looking slightly better in recent data. What's your view on inflation? Is it going to be a major problem?

Goolgasian: Inflation does not look like any type of imminent problem. And for the skeptics of CPI [consumer price index] calculations, even when you look at other nongovernmental calculations. For example, there is the Billion Prices Project, which looks at Internet prices and compares daily prices with a history of a basket of goods. And when you look at the inflation implied in that versus CPI, it's really no different, which is to say near zero. So, we don't think that even if you're skeptical about the government's construction of CPI, we don't really think that there's any imminent danger of inflation here.

But that's not really the issue for real asset investing and inflation investing. You should be designing your portfolio for the potential in the future. I think people are too concerned in the real asset space about what's going to happen in the next couple of months. They are losing the long-term view of how they'll protect their portfolio with some type of "insurance" on inflation for the future. That's really what you need to think about.

From our perspective, some type of allocation to real assets on the optionality of Fed-induced inflation or a growth in the economy that causes inflation makes sense now because there are parts of the real asset environment that looked pretty cheap on a historical basis.

Glaser: On that front, what would you recommend? Something like gold being an option today?

Goolgasian: Gold is certainly something that we've held historically, we do hold it now as well. Gold is, I think, falling under a very simplistic narrative in the marketplace today. The narrative goes like this: The U.S. economy is improving; rates are rising; the dollar is getting stronger; gold is priced in dollars; and for other reasons as well just around growth, gold is going to weaken. And that is basically the byline you see in every news story when gold sells off. You get basically that narrative.

That narrative seems to me very simple and likely not the truth of what's going to happen in the future. The Japanese have moved to full QE [quantitative easing]; [ECB President] Draghi and Europe are going to move to QE from all signals they have sent in the last few months. And I think if we had an outpost on the moon, there would be moon QE, too. The world and the central bankers have adopted a QE framework.

And while the U.S. is certainly slowing that down, there is no doubting that the world and the genie of QE is out of the bottle right now--that this is the go-to move. And my view on that is that's likely going to lead to a policy mistake at some point and likely lead to some major currency upheaval at some point. And one of the best ways to hedge against that is gold.

We have a lot of discussions with clients, and there's a belief out there of "Well, don't you think that the central bankers really helped boost the economy and get everything going again?" A part of the answer to is that we don't know the counterfactual. You'll never get to run the 10,000 stochastic simulations and see what would have happened if they didn't do QE.

So, all you can do is think about if someone was on a desert island for 20 years and came back and said, "How are things going?" And you said, "Well, GDP is growing at 3%, unemployment is under 6, stock market is at an all-time high, trading at 16 times earnings, reasonable valuation, [Manufacturing ISM Report] numbers were just at 10-year highs, and so on." The person would say, "Wow, that's pretty good. What are interest rates at?" You say, "Oh, they are zero." And the next question will be, "Well, how could that be?" And the answer would be, "The people who put interest rates at zero think that that's the reason all of that happened." And we will never really know that, and I'm not sure that that's the case.

But the point is that the central-bank philosophy now is that they can dramatically impact the world through these aggressive QE maneuvers, and one of the only ways to really hedge against that becoming a mistake is through gold.

Glaser: Chris, I certainly appreciate your take on the markets today.

Goolgasian: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.