views expressed in this column are solely those of the author and do
not reflect the views of SVB Financial Group, or Silicon Valley Bank, or
any of its affiliates.
"Just sittin' around drinkin' with the rest of the
Six rounds bought, and I bought
Spent the groceries and half the rent.
fourteen dollars of having twenty-seven cents"
- Roger Miller
With the news last week that Standard & Poor's put the
United States of America on "negative outlook" regarding its AAA rating still
lingering in the air, I'm wondering why this is so important.*
definition, investing is a "relative" game. Like Roger Miller's creative lyric
that he's only short 14 dollars from having 27 cents, is it more important that
he is in the hole $13.73 or that he's down $14?
In the markets, depending
on your investment objectives you take your money and put it in the best
relative investment choice. But you must always adhere to your
overriding investment objectives first, so your return will vary with the
Consider your typical pension fund that is today getting whacked by
low yields. Is their solution to take on more risk? Perhaps, but it should
always work within their predefined investment set.
In other words, just
because investing in death benefits can return 15-20 percent, it shouldn't shift
funds into such illiquid, uncertain options in hopes of gaining higher yields
(It can also return as low as 1-2 percent and leave your funds locked up for
This is why investing with an achievable market-related
benchmark in mind is so important.
Pension funds typically look to their
fixed income managers to outperform the Lehman (I can't seem to get used to
saying Barclay's) Aggregate Bond Index. When the yield curve is high, this index
may pay around 6-8 percent. When it is low, like today, the average yield could
be 3 percent. Like it or lump it, you cannot achieve a return that is not
offered in the marketplace.
It could be that credit ratings are finally
being revealed to have the same characteristic.
On Monday, when S&P
made the negative outlook announcement, Treasury yields actually dropped and
prices rose slightly. By S&P's definition, the outlook change means they are
giving it a one-in-three chance that Uncle Sam gets downgraded sometime in the
next two years.
The market did not react as you might expect given the
news. But when you look at the action through the lens of relativity, it becomes
quite understandable that investors would yawn at such news.
relative world, it seems S&P may only just now be bringing its outlook of
the U.S. in line with the wave of downgrades felt across the spectrum of issuers
over the last three years. In fact, if you consider the breadth and depth of
markets along with trading volume and other liquidity measures, no market comes
close to the U.S. in terms of realistically allocating the safer portion of your
And that means it is still the safest place, by far, to store
Given the market views credit ratings in terms of relative
instead of absolute levels and given the USA will remain the most liquid,
creditworthy market-place for bond investors, doesn't it seem more appropriate
to peg them at AAA and rate every other issuer based on its safety
relative to the USA?
The real problem here is that no one really
knows what "AAA" means. It does not, and never has, meant that credit risk is
zero (take a look at a multitude of AAA mortgage bonds in the post 2008 world
for an eye-popping example).
But instead of clarifying what their ratings
scales mean, the agencies are it seems erring on the conservative side by
downwardly adjusting ratings across the board and, in the process, perpetuating
the "absolute" view of their ratings scales. So, where does this end? Perhaps
with the USA rated AA and all other issuers of any liquidity at some level
At that point, I wonder if there will be an effective "reverse
split" of the ratings scale, given the designation "AAA" has gone out of use?
After all, if no one is rated AAA, AA becomes the new AAA, right?
*For an FAQ on this topic, please click here.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or SVB Asset Management, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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