While some retirees and their advisors clamor for yield-oriented investment strategies, we believe this fascination with yield can result in some unexpected, often unpleasant, consequences. In fact, the current market environment, with all eyes on the timing and pace of an U.S. Federal Reserve interest rate hike, should give yield-seekers additional pause because of the potential for immediate increased volatility.
To help investors evaluate their own investment situation, we’ve extensively researched the overall impact that a focus on yield can have on multi-asset portfolios and concluded that yield objectives over 3.5% begin to erode a portfolio’s capital base. As you can see from the hypothetical scenario below, such erosion can occur at an increasing rate as forecasted yield increases to 5.0%. Unfortunately, too many investors are not only seeking yields higher than 3.5%, but they have ventured into investment scenarios that are significantly tilted toward yield with little regard for long-term risk.
Hypothetical analysis provided for illustrative purposes only.
Many yield-seeking investors have stretched beyond the more traditional sources of yield, such as money market accounts, U.S. Treasuries and investment-grade fixed income assets. Such alternatives can help to provide potential for more short-term income, but at a much higher risk than many investors can withstand given their lower-risk preferences. For example, the yield on U.S. high-yield bonds was 6.6% as of March 2015. But, during the financial crisis, the worst 12-month return for the asset class in the last 20 years was minus 31.2%.1 By comparison, the worst 12-month return for a typical bond portfolio, as represented by the Barclays U.S. Aggregate Bond Index, over the last 20 years, was only minus3.7% from November 1, 1993 to October 31, 1994.
Could your own portfolio withstand a loss of 31.2%? Most retirees would face significant, prolonged lifestyle changes from that type of loss—particularly if that loss occurred at the beginning of their retirement years.
Ironically, many of these investors believe they are taking a “safe” investment approach because they are living on yield-generated income and leaving their principal “untouched”. Unfortunately, this is a potentially costly fallacy if the methods used to boost income result in too much risk and do not allow for capital appreciation. We believe investors who seek responsible yield through diversification by using a multi-asset investment strategy will likely enjoy a potentially more sustainable future income stream and fewer sleepless nights.
In our opinion, the key factors underlying a responsible-yield portfolio are:
Balance: Current income from a portfolio should be balanced against long-term growth requirements.
Diversity: A portfolio should include a mixture of strategies and globally diverse asset classes.
Risk: The assumed risk in the overall portfolio must be weighed against the investor’s risk tolerance.
Adaptability: More frequent monitoring and asset-allocation adjustments are needed because of changing market conditions.
So, it is important to consider how you might build a portfolio aimed at producing sustainable yield. At Russell Investments we choose to take a design-construct-manage approach.
Design: Build a portfolio that produces income, but avoids eroding the portfolio’s capital base and avoids creating too much cost to total return.
Construct: Diversify yield sources and risk profiles within asset classes to help better withstand market stresses.
Manage: Employ mindful, timely management that adapts to ever changing market conditions.
How responsible, or irresponsible, is your yield-oriented investment plan? For more information on Russell’s findings regarding yield-oriented investing, please review our full report.
1 U.S High Yield: Barclays U.S. High Yield Index as of March 2015.
Disclosures
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost.
Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Diversification does not assure a profit and does not protect against loss in declining markets.
Investing for yield involves a number of risks, including those associated with equities, bonds and derivatives.
Stock/Equity investors should carefully consider risks such as market risk when investing. There are no guarantees when it comes to individual stocks. Any stock may go bankrupt, in which case your investment may be worth nothing.
Bonds involve risks such as interest rate, credit, default and duration risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield (“junk”) bonds or mortgage-backed securities. Investments in derivatives may cause the investors losses to be greater than if he/she invests only in conventional securities and can cause the returns to be more volatile.
The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade coporate debt securities, and mortgage-backed securities. (specifically; Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).
Barclays U.S. Corporate High Yield Index: The Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded. The US Corporate High Yield Index is a component of the US Universal and Global High Yield Indices. The index was created in 1986, with history backfilled to July 1, 1983.
Russell Investments is the owner of the trademarks, service marks and copyrights related to its indexes.
Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is a subsidiary of London Stock Exchange Group.
Copyright © Russell Investments 2015. All rights reserved.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.
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