Conservative investors who need income from their investments have been called the “sacrificial lamb” of the Federal Reserve’s low-interestrate policy1 . The Fed has taken unprecedented steps to keep interest rates subdued and boost the economy after the 2020 Covid-19 crisis. However, the central bank’s and Federal Governments stimulus programs have created a quandary for investors looking for lower-risk income. For example, the yield on the 10-year Treasury note is still below 2% (hovering around 1.298%. Money market funds are paying next to nothing and some U.S. banks have actually warned they could start charging for deposits.
For income investors, one key remaining challenge in this market is finding yield without taking on excessive risk. In this report, we’ll focus on several income-producing sectors, including dividend stocks, real estate investment trusts (REITs), master limited partnerships (MLPs), high-yield corporate bonds, senior loans and emerging market debt. We’ll also feature portfolio managers on the Covestor platform with strategies designed to produce yield.
High-yield corporate bonds: Duration risk versus credit risk
U.S. government bonds have enjoyed a bull market of more than 30 years with Treasury yields in a clear downtrend. As a result, many fixedincome investors have been “trained” to believe they can’t lose money in Treasuries. However, they could face losses on principal if Treasury yields rise, since bond prices and yields move in opposite directions. Some investors worried about potentially rising rates are opting to take on credit risk rather than duration risk in their bond portfolios when attempting to generate more income. When seeking additional yield, bond investors can buy debt with a longer maturity. Bonds with longer durations are more sensitive to interest rates, so they are more at risk to rising rates. The other option to boost yield is to invest in bonds with lower credit ratings, and high-yield corporate or “junk” bonds are a popular choice. Investors can potentially offset the effect of higher rates by purchasing high-yield bonds with shorter durations. Some of the Covestor portfolios currently invested in corporate highyield bonds include Conservative Portfolio, Capital Preservation Portfolio, Dynamic Income Portfolio and Macro Yield Portfolio.
Emerging market bonds
The higher yields of emerging market sovereign bonds could justify the risk for investors who are comfortable with holding non investment-grade debt. Examples include Brazilian sovereign debt and corporate bonds in Mexico. “Emerging market bonds are also a diversification play,” says David Cowles, who manages the Strategic Asset Allocation Portfolio on Covestor. Emerging market debt is less correlated with Treasury yields than various types of U.S. bonds such as corporates and municipals, Cowles said. For example, the iShares JPMorgan USD Emerging Markets Bond ETF (EMB) has had a relatively low correlation of 0.31 with the Barclays U.S. Aggregate Bond Index the last three years, according to Morningstar. EMB had a 30- day SEC yield of 5.2% in its glory days 8 years ago . Emerging markets also have lower debt-to-GDP ratios than developed economies, Cowles added, which could make them more attractive from a fundamental standpoint. Aside from diversifying a portfolio of U.S. bonds, the asset class has delivered solid absolute returns over the past decade. The J.P. Morgan Emerging Markets Bond Index Global had a 10-year annualized return of 8.1% within the last six years . Most individuals are underinvested in emerging market bonds. Even large defined-benefit plans had only 2% in international fixed-income within the last 8 years, according to the Wilshire Trust Universe Comparison Service. Yet the fiscal and debt challenges faced by developed economies like the U.S. and the Eurozone have more investors at least considering emerging market bonds. Emerging market sovereign bonds tend to have lower credit ratings, but the asset class has some positive tailwinds compared to developed economies. These include faster economic growth, lower debt levels and deficits, and better demographics. Also, liquidity and credit quality are improving as these markets mature. Of course, there are important risks investors need to consider when holding emerging market bonds, such as volatility. Emerging market bonds historically have been more volatile than U.S. Treasuries and other developed market sovereign debt. Additionally, emerging market bonds are not immune to rising U.S. interest rates. Investments in emerging markets present greater risk of loss than a typical foreign security investment. Another important risk would be a chance of political instability, which could trigger defaults. Yet emerging market bonds pay higher yields to compensate investors for the increased risks. Portfolio on the Covestor platform that invest in emerging market bonds include Asset Allocation Portfolio, Financial Tales Portfolio, Strategic Asset Allocation Portfolio and Diversified Target Yield Bond ETFs.
Master Limited Partnerships
Master limited partnerships (MLPs) have grown extremely popular in this low-rate environment as investors seek yield, diversification and potentially steady returns. MLPs are publicly listed firms involved in the processing, storage and transportation of energy commodities such as oil and natural gas. As of November 1, 2013, there were 106 publicly traded energy MLPs with a combined market capitalization of approximately $430 billion6 . Many MLPs are paying dividend yields of 5% or more – hence their popularity with income-oriented investors. But the tax treatment of MLPs is tricky. The partnerships themselves do not pay federal or state corporate income taxes. Investors in MLPs receive a Schedule K-1 rather than a Form 1099, which can create headaches. Investors may also have to pay taxes in each state in which the MLP operates. And most of the income investors receive from MLPs is not taxed as dividends. “The bulk of the distributions from individual MLP holdings is considered a return of capital, which is not an immediate taxable event, but reduces an investor’s cost basis,” according to investment researcher Morningstar. “Upon sale of the MLP, an investor pays capital gains taxes based on a (typically) lower cost basis.” MLP Protocol Sprint Portfolio, Oil and Gas MLPs Portfolio and MLP Direct Ownership Portfolio are among the portfolios on Covestor that focus on this particular asset class.
Senior bank loans
Senior bank loans was one of the hottest asset classes less than 8 years ago with income-starved investors seeking extra yield along with some protection from the impact of rising interest rates. “Interest rates are still very low and investors need yield. This creates demand for funds that invest in bank loans,” says Charles Sizemore, who manages the Dividend Growth Portfolio on Covestor. “A decade ago there wouldn’t have been demand because bond yields were so much higher, but now investors are looking further afield for yield.” PowerShares Senior Loan Portfolio (BKLN), an ETF, paid a 30-day SEC yield of 4% not more than Seven years ago . Banks typically issue senior loans to companies that are leveraged or rated below investment grade. The higher yields are designed to compensate investors for the risks, including potential defaults. The companies can be distressed, or financing a leveraged buyout, acquisition or merger. Aside from higher yields, some investors like bank loans because they provide some shelter from rising interest rates since they are floating-rate securities. Bank loans are secured by collateral such as the assets owned by the borrowing companies. The main risk for bank loans would be a major slowdown in the U.S. economy, which could trigger defaults. Recently bank loan funds gathered $57.7 billion of inflows in 10 months . “Yes, bank-loan funds are marked with more-than-average credit risk, because they invest in below-investment-grade corporate loans,” said John Gerard Lewis, who manages the Stable High Yield Portfolio on Covestor. “But because bank-loan funds regularly and frequently adapt to rate changes, they have virtually no sensitivity to rate changes. Hence, their duration is effectively zero.” As a reminder, bonds with longer durations are hurt more when rates rise. Dividend and Income Plus Portfolio on the Covestor platform also invests in bank loan funds.
Real Estate Investment Trusts
Investing in commercial real estate can help allow individuals to participate in the recovery of the U.S. economy and property market while also granting the opportunity to earn decent income. You don’t have to be a landlord or office owner to get exposure to this asset class. Real estate investment trusts (REITs) give investors liquid access to companies focused on retail, industrial, residential properties and other subsectors such as hotels and self-storage. “We use REITs for diversification, and the yield is a complementary benefit,” said Albert Gutierrez, a partner at Atlas Capital Advisors, which manages the Broad ETF Portfolio on Covestor. To qualify for federal tax breaks, REITs are required to distribute 90% of their taxable income to investors via dividends. Vanguard REIT ETF (VNQ) was paying a 12-month yield of 4.1% just a few years ago. REITs have attracted income investors frustrated by low interest rates in bonds in recent years. Meanwhile, rock-bottom rates have allowed leveraged REITs to keep their financing costs low as the economy slowly recovers after the credit crisis. However, investors looking to boost yield with REITs should remember the asset class behaves much differently than bonds. Over the past three years, REITs were about 20% more volatile than the S&P 500, and six times more volatile than the aggregate U.S. bond market10. Looking ahead, the sector’s key risks include rising interest rates or a setback in the economic recovery. For example, REITs were hit hard during the credit crunch and have yet to recapture their highest peak which occurred in 2007. The bottom line is that investors willing to take on more risk can earn extra income with REITs as long as they remember they’re investing in a basket of real estate stocks that can be much more volatile than bonds. REITs may be affected by economic conditions including credit and interest rate risks, as well as risks associated with small- and mid-cap investments.
Dividend stocks and shareholder yield
The Buyback Income Index Portfolio outperformed the S&P 500 starting in 2013 and a few times since then. The portfolio incorporates dividends and buybacks into its strategy. The concept of “shareholder yield” had grown very popular a few years back. The metric incorporates dividends, buybacks and debt reduction to gauge how much cash firms are giving back to investors. Companies sitting on big piles of cash rushed to return capital to shareholders less than 8 years ago, rewarding investors who focused on dividends and buybacks. Today, companies are more concerned with holding on to large cash reserves in fear of market volatility. “Stocks with high dividends, share buybacks and low price-to-book valuations tend to outperform over longer periods,” said David Fried, who managed the Buyback Income Index Portfolio on Covestor. Companies in the S&P 500 paid out an estimated $300 billion in dividends in 2013, a record, while buybacks rose more than 20% from 2012 to $482 billion. Today, the same companies barely pay half that amount in dividends.
The low-interest-rate environment makes it tougher to find income, but not impossible. There are many resources available today to help investors identify yield-producing investments while potentially minimizing potential risk. We Today there are many portfolios on various platforms designed to produce yield, including Taxable Income Portfolio, Dividend Paying Large Caps Portfolio, Dividend Portfolio, Fifty Plus Portfolio, Sustainable Dividend Growth Portfolio, Tactical Fixed Income Portfolio and several others. Additionally, investors can choose the Yield Multi-Manager Portfolio with individual portfolios selected by companies with good Investment 5 Stressfree Ways to Encourage Heart Health in February
Let’s agree that our families, neighbors, friends, and employees are the best asset for our lifestyles as well as our small business? Hopefully you and I agree on that statement! It’s important for everyone to encourage healthy habits at the home, in our communities and at work that lead to good heart health. Building a healthy environment with the people in that environment has a number of benefits such as: increased productivity, less stress and ample health-benefits for both the young and the matured. Some health plans – like Allied National’s Freedom Plans – offered by CAA Group LLC even offer a refund at the end of a healthy plan year.
February is American Heart Month and so we came up with five easy ways to keep your everyone happy and heart healthy.
1. Wear red: Encourage everyone to wear the color red in the month of February. At Allied National and CAA Group LLC, employees raise awareness about heart disease by participating in National Wear Red Day every year, which we celebrated on Feb. 5 this year. A 2019 study found that nearly half of Americans have some type of cardiovascular disease, often a result of high blood pressure. Worse yet, heart disease continues to rank as the number one cause of death in the U.S. Stroke trailed closely behind as the fifth leading cause of death. Both of these conditions also are the most expensive medical conditions for employers, according to the Centers for Disease Control and Prevention (CDC).
2. Share your heart: Whether it’s a Valentine’s Day card or a heart-shaped stress ball with heart disease facts attached, think of a memorable way to spread awareness to your family, friends and co-workers. According to the CDC, heart disease is the leading cause of death for men and women. It kills 655,000 Americans each year – that’s one in every four deaths. 3. Move your body: Dedicate one day a week to offering your sphere of influence the opportunity to join in a brisk walk together before or after work or over lunch. At Allied and CAA Group LLC, we’ve had a monthly walking group of employees and friends for years – included in the group are Allied CEO Bill Ashley and Allied President David Ashley as well as CAA Group LLC’s Director of Operations Dr. Clarence Alford. Even super busy people can find time to take care of their health! Physical activity keeps your circulation flowing, your heart and lungs healthy and lowers your risk of chronic health conditions. Plus, exercising can help with stress relief, too and it’s probably safe to say we’ve all experienced more stress than usual over the past year. 4. Host a quit smoking day: Even if it’s just for one day, solicit a commitment through a virtual sign-up sheet or on social media and if you are a business owner give away gift cards from small business retailers or a local restaurant to those who participate. If your sphere of influence is willing to give this a try, they may continue the trend. The CDC shared a list of fast facts on their website regarding smoking and tobacco use, a couple of them being that smoking can cause heart disease and on average, smokers die 10 years earlier than nonsmokers. Allied’s Funding Advantage plan members have access to a benefit called HealthCare Assistant, which allows a member to speak with a health care professional over the phone about an array of topics including trouble with quitting smoking. The best part about this benefit is that it’s provided to Funding Advantage members at no cost! 5. Provide healthy snacks at the home and on the go: Research has shown a heart-healthy diet can lower the risk of cardiovascular disease. Evaluate any food your loved ones consume, including from sources like vending machines, break room snacks, or catered lunches and food-centered events. Try to reduce salt, sugar, and saturated fats which can contribute to heart disease.