The Chase for Yield

by Ben Carlson, A Wealth of Common Sense

“People become risk-seeking when all their options are bad.” – Daniel Kahneman

According to a recent Blackrock report, 81% of the global bond universe currently yields below 4%.

This means income-seeking investors in search of higher yields have been forced to go further out on the risk spectrum (the whole point of the Fed’s interest rate policy). Junk bonds, preferred stocks, bank loans, REITs and dividend-paying stocks seem to be on the list of favorites for those with a penchant for income.

I have no problem with these investments on a stand-alone basis. Any investment can be useful in certain environments. But that doesn’t mean they’re all necessary for your portfolio.

Investors must be aware that investment grade bonds have an entirely different risk profile than these income alternatives. Earning a higher yield comes comes with taking more risk. There’s no free lunche when chasing yield.

While stocks are up big from the 2009 lows and haven’t had a correction in some time, many seem to forget that the summer of 2011 saw close to a 20% drawdown during the European debt crisis.

This period is a great example of the risks in these higher yielding assets. These are the various ETFs for the most popular income alternatives along with their current yield and the losses incurred during that last big flare-up in the markets:

You can see the yield differential between these investments and bonds. All of the alternatives currently offer higher yields and the potential for higher returns than low yielding bonds. But those yields come with the possibility of much larger losses when risk aversion hits the markets.

Again, I’m not saying you shouldn’t be in any of these particular assets. It just helps to know and understand the risk involved when reaching for yield.

These investments can have a place in your portfolio, but you are fooling yourself if you think they will protect you on the downside just because they come with an income stream.

Source:
A disappearing act (Blackrock)

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