Content provided by Rusty Vanneman, CFA, CLS Chief Investment Officer

Concept of earning balance of a businessman

In recent years, given how low interest rates have been, there has been an increased appetite for income-oriented portfolios. CLS, in fact, has several income-oriented strategies, including a new one to be launched in June. We believe these actively risk-managed portfolios make sense for the right investors.

First, let’s contrast an income strategy from a total return strategy. The key difference is that an income strategy focuses on income, but a total return portfolio considers both components of total return: income and capital appreciation.

For many investors, who have moved from the accumulation stage to the distribution stage of their investing life cycle, income strategies may take on additional importance, particularly if an investor has a specific yield requirement.  Still, there are a few things to keep in mind regarding income-oriented portfolios.

For starters, they take on more risk than many investors realize. These are NOT bond substitutes.  They take on more risk than a conventional bond portfolio and they do not diversify (i.e., reduce over-all portfolio volatility) as well either.   The additional risks include:

  • Credit risk: the chance a bond could default (which is greater the lower a bond’s credit rating)
  • Equity risk: some income strategies have direct risk to the stock market through dividend-paying stocks, real-estate investment trusts (REITs), etc.
  • Concentration risk: some income strategies, particularly those that have equity exposure, may be concentrated in some sectors that have higher yields – and higher unintended risks.
  • Liquidity risk: some asset classes are not as liquid (i.e., they are not as easy to buy and sell) as others and therefore they have higher yields to entice investors
  • Duration risk: some bonds have higher duration (i.e., more interest rate sensitivity) as they have more exposure to long maturity bonds
  • Leverage risk: some income strategies have exposure to closed-end funds (CEFs), which are mutual funds that trade on an exchange like stocks (though unlike ETFs, there is no mechanism to keep their price close to their net asset value, or NAV). Some CEFs are levered, which during times of market stress can mean larger losses than unlevered strategies
  • Tax cost risks: income strategies also tend to be less tax efficient than total return strategies as income is taxed at a higher rate than capital appreciation.

Add it all up, income strategies often have more risk than many investors expect.  At CLS, for example, many income-oriented strategies have Risk Budgets that are about 2/3rds as volatile as a global equity portfolio.  For comparison, a bond portfolio has about 1/5th the volatility.   To re-state it another way, income strategies have about 3x the risk. And keep in mind that traditional bonds are better over-all portfolio diversifiers and are generally able to attain additional portfolio volatility reduction.

The art of investing isn’t necessarily always about the maximization of a total return given a level of risk.  Rationally, it arguably should be, but for many investors (given their unique objectives, emotional capacity to take risk, financial capacity to take risk, etc.), to reach their investment objectives, other strategies are required.  For many investors, an income-oriented approach – one that is trying to either target a specific yield, create a dependable income stream, or just maximize a yield given a level of risk — is exactly what they need to reach their goals.

Thanks for reading. Stay balanced.


The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change. No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recom­mended in this report and should understand that statements regarding fu­ture prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.