Why bond investors are the new 'walking dead'

Walkers from "The Walking Dead"
Source: AMC
Walkers from "The Walking Dead"

If you have bonds in your portfolio today, you may be turning into an investment zombie.

Bonds have outperformed other asset classes in the past, which has many investors blindly marching along, now suffering undead yields and not questioning the sanity of a system overloaded with debt. Meanwhile, Federal Reserve Chair Janet Yellen is preaching the legitimacy and effectiveness of quantitative easing, all the while draining the life and diversification out of your portfolio.

In today's economic landscape, the contagions that are infecting investors globally are negative rates and low bond yields.

Increasing stock and bond correlation has investors mindlessly moving in lock step, assuming that what's worked in the past (a mix of 60 percent stocks and 40 percent bonds) will continue to benefit their portfolios going forward.

But the Fed doubling down on artificially low interest rates for almost a decade may have doomed the bond investor – as well as the saver and retirement investor – to a world where the rules have changed.

For those who have become wise to the changing landscape, the hunger for yield has them searching outside of U.S. Treasurys or municipal bonds. Unfortunately, this ends up contaminating their portfolios with even more equity risk and less portfolio diversification. So the contagion mutates and corrupts portfolios in a different way.

"The problem for bond zombies today is that there appears to be no good antidote."

The problem for bond zombies today is that there appears to be no good antidote. If interest rates continue to fall and eventually turn negative, investors will continue to search for yield in places with creeping correlation. If rates stay the same, expect more marching in place, without much hope for better portfolio yields. And if rates go up? Then bond investors may face losses and portfolio dismemberment.

As the pandemic of negative rates spreads to more countries, the amount of bonds in negative territory (currently more than $13 trillion) is likely to bloat. Total global debt is now more than three times the amount at the start of the credit crisis, and this is already beginning to eat away at the average investor.

The amount of debt, not to mention how much of it has a negative interest rate, is so widespread it is hard to keep in context. All the while, hope that rising global debt will ever get paid back is dwindling.

How can you protect yourself from the bond zombie virus? By avoiding diversifiers that are alternatives in name only. Instead, go for investments that access risks that aren't tied to stock market moves (equity risk) or interest rate fluctuations (bond risk) like quality alternative investments such as gold or trend strategies like managed futures.

These high-quality alternatives work like Rick Grimes and Daryl Dixon of AMC's "The Walking Dead." They help form a team with equity and bond risk that can survive and even thrive when traditional portfolio allocations succumb to the scourge.

Now there's only one question to answer: Are you ready for the bond zombie apocalypse?

Commentary Stephen Scott, managing director at Longboard Asset Management, an alternative investments firm specializing in long-term trend following strategies.

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