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Really Dumb Alternative Income Hedges

|Includes:AGG, BOND, iShares TIPS Bond ETF (TIP)

I frequently gripe about the nearsightedness of fixed-income portfolio managers and their investors. It seems to me that the best they can do is eek out minimalist returns with ZIRP distorting credit markets. Hanging on at the top of a bond market is dangerous when the only place interest rates can go is up. Holding long-duration fixed income investments of any kind is suicidal on the cusp of hyperinflation. Money managers look for alternatives to conventional credit products, like in Index Universe's ETF Report article on alternatives in fixed-income for October 2013. They're not looking hard enough to impress me.

No way will I look at bonds, loans or notes that float with Libor. That rate is still subject to manipulation and a few fines aren't fixing anything. The World Bank should give me a call if it ever takes note of my GIBOR concept and wants to implement it worldwide.

I am sick and tired of hearing about variable demand rate obligations (VRDOs). Those instruments were among the first to freeze in value during the 2008 financial crisis and most investors sold out of them in frustration as soon as they could. I tried pitching them when I was a financial advisor in 2005-6 and none of the so-called fixed-income experts at my firm could ever give me consistent answers on how they were priced or how they paid interest. Brokerages were labeling them as "cash alternatives" simply because they were subject to auctions that had not failed . . . until 2008. The fine print of a VRDO prospectus mentions that the instruments' viability in auctions is backed by a credit facility known as a standby bond purchase agreement. If an investment bank is unwilling to lend in support of such an agreement, the VRDO auction fails and the investor is stuck holding what becomes de facto a long-term bond. That will be dangerous during the onset of hyperinflation.

International bonds might work if they originate in countries that have a strong rule of law orientation, a significant hard asset sector, and a low propensity to hyperinflate. That rules out anything except bonds from Australia, Canada, New Zealand, and Switzerland (which lacks the hard assets of the other three, unless you consider Swiss chocolate). I tune out the remaining China bulls who think dim sum bonds are China's ticket to reserve currency status. That makes me LOL. Investors who ignore China's debt-laden shadow banking system deserve what's coming if they love dim sum bonds so much.

I've blogged about BDCs before. They work great in normal times by providing asset-secured loans to companies that can't qualify for low-interest bank loans but aren't in such distress that they need investment banks to underwrite high-yield debt. These aren't normal times. Hyperinflation will enable debtor companies to repay BDCs with less valuable future currency. I expect the market value of BDCs to plummet in hyperinflation unless they supplement their loan portfolios with standby equity distribution agreements.

Fixed-income investments remain a minefield for many reasons. Rising US interest rates will lower bond valuations. Hyperinflation will destroy bonds altogether. Fiscal cliff wrangling makes non-US institutional investors more likely to dump US dollar bonds at any moment. Very few coupon-based securities are going to tempt me to chase yield under these conditions.

Final note: Here is the original version of this article.

Stocks: TIP, AGG, BOND