Content provided by Case Eichenberger, CLS Client Portfolio Manager
2015 was no doubt a tough year for the stock market. In fact, the average investor lost about 3% for the year. While not even close to bear market territory, these are disappointing gains nonetheless. Of the major asset classes, only the S&P 500 had a gain above 1%, including dividends. Investors utilizing diversified income strategies likely did not fare any better, even with attractive yields offered by some areas of the market. Here’s a quick breakdown of some often-used areas of the market to grab yield:
- Large-Cap Value Stocks – These tend to trade at lower P/E ratios and have higher-than-average dividend yields. Investors looking for yield will tend to follow value stocks. This area, represented by IVE, an ETF that typically offers a higher yield than the S&P 500, performed much worse in 2015. It trailed the S&P (in total return, counting dividends) by more than 4%.
- International Value Stocks – Investors have shied away from international stocks for the last several years due to underperformance against U.S. benchmarks. But international stocks are offering higher dividends than the U.S. by about 1%! Not to mention the added benefits of potential risk reduction, lower correlation, and differing return streams. EFV, a proxy for developed international value stocks, underperformed U.S. benchmarks in 2015 largely due to the rising U.S. dollar against foreign currencies.
- Real Estate – This has always attracted investors due to the high income it must pay out. To qualify as a Real Estate Investment Trust (REIT), a real estate firm must pay 90% of its taxable income to shareholders as dividends. Represented by IYR, this sector performed very well in 2015, besting the S&P 500, but just barely.
- High-Yield Bonds – Corporate bonds rated below investment grade have always been popular investments of income-seeking investors. They tend to behave more like stocks than bonds and carry more credit risk, thus offering more yield than normal bonds. This area of the market had a rough year in 2015, mainly due to its energy exposure. Represented by JNK, a broad, high-yield ETF proxy, it was negative by just more than 6%.
- Investment Grade Credit Bonds – We finally get to boring old bonds. Bonds are the best diversifiers for stocks and pay coupons and interest to their investors. CRED, the ETF proxy for a core investment-grade corporate bond market has a higher yield than cash, but it performed negatively in 2015 by about 1%. That was mainly due to its longer duration and widening credit spreads.
So what are investors to do if they are looking for a higher yield than cash? Above are some frequently used options, but even some of the lowest risk options can return negative. Another option is to invest in a diversified fund or strategy, one that uses multiple asset classes to generate yield. Diversified options, such as the $75 billion Franklin Income Fund or the Multi-Asset Diversified Income ETF, are currently offering high yields of more than 5%, but these should not be confused with pure bonds funds. They are not without risks and they were also in the red in 2015. In fact, both were down by 7-8%.
Diversified approaches help ensure investors do not take an extraordinary amount of risk in any one asset class. But they do not protect investors from all risk, and declines can and will happen, even with the extra yield. The best option is to seek only the amount of yield necessary to generate and manage in a diversified way that withstands varying market cycles.
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An ETF is a type of investment company whose investment objective is to achieve the same return as a particular index, sector, or basket. To achieve this, an ETF will primarily invest in all of the securities, or a representative sample of the securities, that are included in the selected index, sector, or basket. ETFs are subject to the same risks as an individual stock, as well as additional risks based on the sector the ETF invests in. An income-generating asset is one which seeks to provide a return on investment by taking positions in various securities designed to grow principal. Specific securities selected to achieve this goal may vary greatly. Diversifiable risks do exist but vary based on the specific securities chosen. One over-arching diversifiable risk is the liquidity risk. Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.