If you’ve been managing money over the last six years, at some point you’ve been asked “when are rates going to rise again” followed by the even harder “what am I supposed to do for retirement income?”
Following last week’s equity rout that saw the S&P 500 pullback 2.69% and the ten year Treasury yield drop another 7.8%, investors and their advisors are wondering if they’re right back to where they were in 2011. Should they commit more to their bond portfolios and the possibility of negative real rates of return or just given in and join the chase for higher dividend yields in equities? Everyone else did in 2014, but with the Real Estate iShares up 5.71% in January and the SPDR Select Utilities Sector ETF up 2.33%, what happens to your portfolio if the Fed decides to hold off on rate hikes or gulp, starts QE4? Will it be 2013 all over again?
Using the ETFG Scanner to screen funds based on trailing twelve month yield is one way to find a higher yielding investment, but what about those investors who aren’t interested in picking up pure high yield bond exposure or Brazilian equity exposure? First, change the filter under “Focus” to multiasset-target outcome and resort the list based on assets under management. A whole cottage industry has grown around developing funds generating higher income with less volatility and the number of funds has grown substantially over the last several years with our filter showing 26 funds in this space, most in existence for less than three years and with a mix of active and passive managers. And while there may be a flavor for every investor there are, broadly speaking, two basic investment models they employ.
First are those funds that invest in what would be considered the “classic” high income categories that you’ve probably had pitched to you by a fund wholesaler such as REIT’s, MLP’s and preferred stocks although a small allocation (20% or less) may be set aside for high yield bonds. The focus is on generating income but with more equity upside potential and consequently, more equity volatility that some conservative investors might want. The two largest funds on our list fall into this category with the Guggenheim Multi-Asset Income ETF (CVY) with a strong leaning towards financials (30.9%) and energy stocks (23.51%) which weighted heavily on the returns in 2014, down 4.33% and 1.92% in 2015. The First Trust NASDAQ Multi-Asset Diversified Income Index Fund (MDIV) relies on the same equity categories to generate the bulk of its returns although the largest single allocation is in a sister fund, the First Trust Tactical High Yield ETF (HYLS), which as the name implies is all high yield bond, all the time. That high yield bond exposure helped dampen some of the downside volatility although the strong 8% return in 2014 had more to do with the REIT allocation, currently around 33% of assets.
The other (and better performing option so far this year) is to turn to the “conservative allocation” space, where the allocation is more bond-centric with smaller equity allocations that could provide some upside potential but more tend to cushion capital loss in the event of a bond sell-off. A prime example would be the iShares Morningstar Multi-Asset Income (IYLD), a fund-of-funds product that unlike CVY or MDIV can boast a positive YTD return of 1.72%. The secret to its success is a 60% bond allocation although only slightly less than 6% is invested in the iShares 20+ Year Treasury Bond ETF (TLT). Approximately 45% is being put to work in investment grade and high yield credit with 20% invested in mortgage REIT’s and International REIT’s. While that large bond allocation helps IYLD offer a lower standard deviation of 6.6% compared to 9.83% for CVY, the trade-off is what happens in a rising rate environment. In 2013 IYLD delivered an uninspiring .47% return compared to 19.42% for its equity heavy brethren CVY.
For those investors who want another option besides building portfolio’s around REIT’s or Treasuries might want to consider the active management space where two funds, the AdvisorShares YieldPro ETF (YPRO) and SPDR SSgA Income Allocation ETF (INKM), have stood out from the pack with strong performance in 2015. Both funds actively rotate between cash, fixed income and equities seeking to maximize risk and return; YPRO does so with a targeted absolute volatility of between 2% and 6% (according to AdvisorShares, it has around 2.65% since inception) while INKM doesn’t specify any specific risk target. These two funds might seem like convenient one-stop shopping and you would be right because they were intended to be used as core holdings within a portfolio, meaning that the principal downside for some asset allocators would be the fact that the allocation does actually shift and could leave your clients with more equity or interest rate risk than they would be comfortable with.
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