The obsession with income is unwittingly steering individuals towards assets that are divorced from economic reality and could be painful in the long run. Advisors and investors looking to generate attractive returns in today’s market need to consider being more diligent.
We all know that yields on the highest-quality bonds, especially Treasuries, no longer suit the needs of retirees and those nearing retirement. The solution has been to invest in equities with dividends above what bonds pay.
Talk to advisors or read the articles about these stocks, however, and a disturbing theme emerges: often, there is no mention of a company’s financial prospects or an understanding of how attractive the security’s pricing is.
Chasing income can have unexpected, disastrous results. Investors avoid Treasuries at the precipice of an interest rate rise because, of course, they know that these securities can quickly lose value. Yet what they may not realize is that these so called “bond replacement” securities can also show dramatic declines once rates start to move.
For example, from July 30th to September 17th this year, when a rate rise seemed on the cards, income proxies like the XLU Utilities ETF (with a 3.2% yield), the XLP Consumer Staples ETF (2.4% yield) and the IYR Real Estate ETF (3.9% yield) declined by 5.5%, 3.4% and 7.18%, respectively. In each of these cases, the declines were much more dramatic than the income they produced.
Thus, we see the risk that comes with chasing yield. Investing in companies because they pay a good dividend while overlooking their growth prospects or their valuations can expose investors to losses that negate the income. It’s absurd.
A fresh approach to asset selection is in order. There are assets out there which provide income and have strong growth prospects. Finding them in this market simply means that advisors and investors have to roll up their sleeves and look beyond just dividends or yields.
One area we often like to highlight is the high-yield corporate bond market. High-yield corporate bonds aren’t necessarily anyone’s favored asset class, but a deeper look at some of the dynamics happening in this market brings up some intriguing prospects.