09/12/2012

Pursuing Higher Investment Income in a Low Yield Environment: How We Think It Should Be Done

This May we wrote about EverBank Wealth Management's approach to constructing yield oriented portfolios as a potential solution for investors seeking income. In the four months since, an increase in asset values in many markets has led to further compression in yields. While the current environment continues to encourage some investors to accept more risk in search of income, we believe understanding the risks associated with many yield-focused investment strategies is more critical than ever.

Depending on an investor's tolerance for risk, there are many strategies that may prove effective in meeting the goal of increasing income. However, we strongly encourage investors to harness the benefits of diversification and volatility management. Combining yields from different assets can be used to create a more robust portfolio with a higher level of expected return per unit of risk. Additionally, this portfolio should help protect investors against unanticipated inflation and declines in the U.S. dollar.

These risk-based considerations, and the need for yield by our clients, led us to create the EverBank Wealth Management Enhanced Yield portfolio.

Enhanced Yield Portfolio Construction

Utilizing a risk-led portfolio construction approach, the Enhanced Yield portfolio attempts to balance the risk versus yield dynamics of today's market. This is a discretionary product that will be actively managed to adjust to changes in this environment. However, the tenets of diversification and the need for protection against specific secular events will not change.

This portfolio uses ETFs and mutual funds to achieve the optimal exposure to each strategy and benefit from active management where outperformance or risk reduction may be achieved. The Enhanced Yield portfolio is currently targeted to yield 5% to 6%1, with a projected volatility of 8% to 9%2 over full market cycles.

Enhanced Yield Portfolio Allocation

Stable Return
  • 12% Multi-Sector Bonds
  • 10% Global Sov. Debts
  • 10% IG Corp. Debt
  • 10% EM Local Debt
  • 8% Global Agg. Bonds

Growth Assets
  • 10% High Yield
  • 8% MLPs
  • 6% U.S. High Div. Eq.
  • 3% Global Real Estate
  • 3% Preferred Stocks

Inflation Protection
  • 10% Global Inflation Linked Debt
  • 5% Leveraged Loans
  • 3% Cash
  • 2% CMBS

Underlying Yield Strategies

High Dividend Equities - High dividend equities have received significant coverage since dividend yields of many stocks exceeded those of ten-year Treasuries. While the current yield of the S&P 500 is approximately 1.9%, many diversified dividend focused mutual funds and ETFs offer yields between 3.5% and 4.5% by investing in high quality equity securities.

Preferred Stocks - Preferred stocks are hybrid securities that provide ownership interest in the issuing entity and often provide a dividend yield, similar to a bond coupon. Currently, commonly quoted preferred stock indices are yielding between 5.5% and 6.5%. Investors should anticipate the volatility of preferred stocks to be similar to equities and to experience illiquidity in volatile markets. Additionally, investments in preferred stocks are often concentrated in the banking and financial sectors and can experience illiquidity in certain market environments.

Real Estate Investment Trust (REITs) - Despite the potential for higher tax treatment, the high dividends of REITs have often been attractive to income-focused investors as a liquid avenue for investing in commercial real estate. Many investors are also attracted to the REIT's requirement to pay out 90% of their taxable income to investors. Well-diversified mutual funds and ETFs currently report yields between 3% and 4%. Investors should expect REIT volatility to be similar, if not slightly higher, than that of broad equity markets.

Master Limited Partnerships - MLPs are publicly traded companies that primarily transport and store natural resources and, similar to REITs, are able to avoid entity level taxation (this may imply special tax treatment for the investor). Also similar to REITs, MLPs distribute most of their income to investors leading to large yields, currently ranging from 5% to 6%.

High Yield Corporate Debt - High Yield debt is defined as debt that has not obtained an investment grade rating of BBB- or above from a rating agency. These bonds are associated with higher levels of default than investment grade ratings and in return investors demand a higher coupon. High yield indices are currently yielding approximately 7.3%.

Floating-rate Loans - Floating-rate loans, also known as levered loans or bank loans, are debt securities where the interest rate adjusts ("floats") with changes in a short-term index, most often LIBOR. This feature is often seen as a potential source of inflation protection, benefiting investors in rising interest rate environments. Floating-rate debt is issued by banks (vs. the credit entity) and generally used as an alternative source of financing to below-investment grade firms in need of capital. While these loans are senior in the capital structure to other debt, the prices of these loans are considerably more volatile than investment grade debt. This additional risk is reflected in the yields, currently floating rate note mutual funds and ETFs are generating yields ranging from 5.0% to 6.5%.

Emerging Market Local Debt - The debt of emerging markets denominated in local currency is a rapidly growing, and increasingly important, sector of the fixed income markets. Yields on emerging market debt indices currently range from 4.5% to 5.5% and average credit quality for most of these indices are investment grade. This reflects a spread of over 200 basis points over comparable developed market sovereign debt. In addition to yield, investors also receive currency diversification, which could provide protection against declines in the U.S. Dollar. Investors should note, however, that the currency component of return could generate volatility levels similar to equity investment strategies.

Asset-backed Debt - The most common type of asset-backed debt is Residential and Commercial mortgage-backed securities, but this category also includes auto and student loans, equipment trusts, and several other structured vehicles. Yields vary with asset type and credit quality, as do liquidity and risk characteristics.

Investment Grade Corporate Debt - While in today's environment most of the highest rated debt securities are yielding no more than 4%, for investors with limited ability to risk capital, this asset class is compelling when compared to Cash and Treasuries. Currently, most investment-grade corporate balance sheets are relatively conservatively positioned and most bond analysts are predicting default rates of less than 2% for non-financial investment grade issuers over the next year.

Evaluating Yield-Focused Investments

The yield-focused strategies included in the Enhanced Yield portfolio have been selected based on yield, return, and risk characteristics. Additionally, the portfolio includes assets designed to moderate total portfolio volatility and protect against unanticipated inflation and secular declines in the US Dollar. We encourage investors evaluating any yield-focused strategy to evaluate the role of investment income in meeting goals, income requirements, and tolerance to sustain short-term capital losses. We also encourage investors to consider their time frame. While it is not possible to predict when we will return to a higher interest rate environment, few financial professionals expect interest rates and credit spreads to remain at historically low levels indefinitely. Investors should weigh the opportunity cost associated with investing in low risk, low yielding strategies against a higher probability of preserving capital to invest in a higher interest rate environment.


  1. Target Yield: The yield range estimate is derived from the current distribution yields of each underlying fund as of September 30, 2013. Yields of underlying funds can vary dramatically with market conditions and changes in portfolio allocation. SEC yields will vary from distribution yields.
  2. Target Volatility: Target volatility measures the expectation of the degree of variation of investment returns around the mean (or average) return. The expected values are modeled using historic data. Realized volatility could be materially higher or lower than the target volatility.
RISKS: Please refer to EverBank Wealth Management's ADV Part 2 for more information. Past performance is not indicative of future returns, and the value of investments and the income derived from them can go down as well as up. Future returns are not guaranteed and a loss of principal may occur. Diversification strategies do not ensure a profit and do not protect against losses in declining markets. EverBank Wealth Management's portfolio risk-management process includes an effort to monitor and manage risk, but should not be confused with (and does not imply) low risk. There are risks associated with any investment approach, and the Enhanced Yield portfolio has its own set of risks to be aware of. These risks include weights in riskier asset classes, such as equities. Some specialized ETFs can be subject to additional risks. Investment returns will fluctuate and are subject to market volatility such that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Asset classes and the proportional weightings in the portfolios may change at any time without notice, subject to the discretion of EverBank Wealth Management. International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

about the author

Christie Zarkovich, CFA

Christie’s career began at the New York Mercantile Exchange, and for over 15 years, has included service as a senior investment professional at some of the nation’s leading foundations and endowments. From her varied experience, Christie has gained the investment analysis skills needed to better understand today’s global financial industry.