The good news for income investors
is that interest rates appear to be on the rise. As of February 16, 2017, the 10-year U.S. Treasury yield has risen over 100 basis points since its post-Brexit
low of 1.38% on July 5, 2016. These increased yields should help some investors reach their income targets.
The bad news is that the search for income is still challenging. A 2.45% yield on the 10-year U.S. Treasury note (as of Feb. 16, 2017) still does not represent a lot of income. And if bonds have been a primary source of income, then the fourth quarter of 2016 would not have been encouraging: the Bloomberg Barclays U.S. Aggregate Bond Index was down -3%, marking its worst quarter since the third quarter of 1981.
Disappointing results and low yields can cause investors to seek other avenues for income, many offering the allure of higher returns as well. For example, in December 2016, U.S. high yield (Bloomberg Barclays U.S. High Yield Index), global high yield (Bloomberg Barclays Global High Yield Index) and emerging market debt (Bloomberg Barclays Emerging Markets Debt Index) offered current yields of 7%, 6.2% and 5.1%, respectively. Certain non-fixed income asset classes also offered competitive yields: MLPs (Alerian MLP Index) came in at 8.2%; global infrastructure (S&P Global Infrastructure Index) posted 4.3% yields and global real estate (FTSE EPRA/NAREIT Index) 3.8%.
However, these higher yields are not free: the downside risk can be substantial. Some investors may recall when MLPs (Alerian MLP Index) lost -32.6% in value for the calendar year 2015 when oil prices plummeted. As the chart below shows, the 2015 declines were not even the worst 12-month losses some of these higher yielding sectors have experienced: based on data going back to January 1994, MLPs, global real estate and U.S. high yield bonds have experienced 1-year downturns of -39.7%, -59.9% and -37.1%, respectively. In contrast, the U.S. Treasury Index’s worst 12-month return since 1994 was -3.6%.
Click on the images below for full view.
Two considerations for income investors in the current environment
- Be cognizant of potential risks – they can be substantial, as the chart above illustrates.
- Diversify your income sources. While many investors are attracted to high-dividend paying stocks and high-yielding bonds, an over concentration in those kinds of assets can create unintended long-term risks. We believe that thoughtfully combining a broad range of equity, real assets and fixed income securities that have both income and growth potential may help income investors reach their targets.
The bottom line
With interest rates apparently on the rise, income-seeking investors may have an easier time meeting their income targets. That said, risks remain, particularly for investors who may have stretched for yield. Diversifying sources of income and thoughtfully combining asset classes that can provide both income and return may help investors navigate the uncertainty of the months ahead.