Searching for sustainable yield is never easy, but over the last decade, income investing has been a most unpalatable cocktail — one part frustration and two parts despair (add bitters to taste). With 10-year treasuries near all-time lows and the Federal Reserve embarking on a fresh easing cycle, the hunt for yield will only intensify.
Necessity Is the Mother of Invention
The unfortunate reality is that a deep chasm stands between investor income requirements and what conventional strategies can now yield.
In a market where every basis point of income counts, many yield-focused strategies simply do not generate as much income mileage as may be imagined. For instance, high-yield dividend strategies generally manage a low 3-handle yield, and real estate achieves a somewhat higher 3-handle distribution. This prompts the obvious question: How is a saver supposed to retire on a 3-handle income stream? Even junk bonds, with all their attendant credit risks, may only deliver in the low 5-handle range. Strikingly, this threshold is the upper limit for mainstream income strategies, and yet these yields may still be insufficient for many investors.
This dearth of income has refocused the paradigm on retirement, forcing advisors and clients to reevaluate lifestyle goals within the context of the possible, hemmed in by low yields. But what if there were strategies that could achieve four times the yield of the S&P 500, with less volatility?
Welcome to the world of alternative income and pass-through securities. Perhaps the problem hasn’t been that income doesn’t exist in this market, but simply that we have been conditioned to look for income in all the wrong places.
The Unusual Suspects
The solution to this income stream problem may lie in an ecosystem of alternative investment beyond the frontier of conventional options. The three prominent contenders in this high-yield arena are closed-end funds (CEFs), business development companies (BDCs) and master limited partnerships (MLPs), achieving yields of 7.55%, 9.54% and 8.17%, respectively. How do they do it?
What these assets have in common is they may exploit unique fund structures or target specific risk profiles to hit income in excess of traditional methods. Their pass-through structures avoid the double-taxation phenomenon, enabling higher yields for the end investor.