The world’s central banks — the Bank of Japan, the European Central Bank, and the Fed — are tasked with managing inflation within the global economy. In recent years, inflation (as defined by rising prices for goods and services) has remained relatively low.
However, by lowering interest rates in their quest to spur inflation and economic growth, central banks have created inflation when it comes to the cost of retirement. And today, it is much harder to retire on a fixed income than it was 20 years ago.
A look back to 1999
In 1999, an investor could generate a return of 4% ($40,000 per million) after tax without taking much risk. At that time, the 10-Year Treasury was at 6.25%¹, meaning that an investment-grade bond portfolio could earn roughly 7%. Assuming an investor was in the 39.6% federal income tax bracket and the 3% Illinois state tax bracket, this means their total tax liability was 42.6%. Of that 7% return, 3% went toward taxes and the investor retained the remaining 4%. Factoring in 2% for inflation, this represents an inflation-adjusted return of 2% per year.
In 2006, just as in 1999, the yield curve was flat and there was much investor interest in the tech and IPO market. In 2006, however, the amount per million an investor could reliability earn had dropped from $40,000 to $34,000 after taxes, even though the top tax rate had been lowered to 35%. Adjusted for inflation, the investor could barely earn a positive return.
Today, the top tax rates at the federal and state levels exceed 45%, and the $40,000 per million return that was achievable in 1999 is now $14,000 per million — a negative real return when adjusted for inflation. As a result, investors have been encouraged to take on more risk.
Not isolated to individual and institutional investors, State governments have also been impacted by low rates. According to Moody’s, Illinois had roughly $250 billion in unfunded public pension liabilities at the end of 2018.²
Navigating Negative Rates
Today, central banks own roughly 80% of the $17 trillion in negative-yielding securities that exist around the world.³ These central banks have distorted discount rates, and every PE buyer, real estate developer, corporate CFO, or other capital allocator is operating in a world of financial repression. We don’t know how long this anomaly will last, but unless an investor can fund their retirement with a return of $14,000 per million, they’ll need to consider off-the-run opportunities.
At RVP, we focus on solving this exact problem. We look for opportunities within niche markets, and we believe that more tactical opportunities will present themselves over time. Having a game plan is a vital part of navigating tumultuous markets, and for that reason, we provide each client with:
- An investment policy statement that defines investment goals and the strategies that will be used by our team in pursuit of those goals
- Disciplined portfolio rebalancing, to ensure that asset allocations remain inline with target allocations and stakeholder expectations
- Comprehensive guidance that covers asset allocation, financial planning, and tax planning
- A proven investment philosophy that brings decades of documented management experience to the table
- Technology that can aggregate information from multiple custodians, providing the data that drives informed decisions
Through this work, our goal is for each of our clients to take a more disciplined approach to risk management and to avoid behavior mistakes that can be encouraged by volatile markets. After all, risk should be defined as permanent loss of capital – not a standard deviation.
If you’d like help navigating today’s markets, we invite you to connect with our team.
ABOUT THE AUTHOR: ROBERT HUFFMAN III, Co-Founder / Chief Executive Officer
Bob Huffman co-founded Relative Value Partners in 2004 with Maury Fertig. As Chief Executive Officer, he oversees the management of RVP’s investment strategies, in addition to being responsible for the business development and strategic growth of the firm.
An industry veteran with more than 30 years of experience, Bob’s investment acumen began in Fixed Income. He spent two decades at Salomon Brothers/Citigroup, serving in various roles within corporate bond sales to eventually become the Head of Midwest Institutional Fixed Income Sales. At Salomon Brothers/Citigroup, he worked closely with chief investment officers and senior portfolio managers at many major financial institutions across the country. His experiences and learnings there helped form the initial vision behind RVP.
¹ Reserve Bank of St. Louis, 10-year Treasury Constant Maturity Rate
² Crain’s Chicago Business, $250,000,000,000 and Counting
³ Bloomberg, The Unstoppable Surge in Negative Yields Reaches $17 Trillion
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Relative Value Partners, LLC which can only be provided through a formal advisory relationship. Clients of the firm who have specific questions should contact their Relative Value Partners counselor. All other inquiries, including a potential advisory relationship with Relative Value Partners, can be directed here.