By Brian Fairhurst
As manager of the iShares internal wholesaler desk, I get to hear the types of questions financial advisors are grappling with on a daily basis. If I took a poll of the team today, hands down the question they are hearing most often from advisors is, “Where can I find yield?” It sounds like a simple enough question – even in a low yield environment such as this one, there are certainly income opportunities to be found in equities (REITs, energy stocks), fixed income (high yield bonds) and in between (preferred stock).
Yield problem solved, right? Well, not so fast. The question we’re getting from advisors is not just about yield – it’s also about risk. Often when an advisor asks, “Where can I go for yield?” what they’re really asking is: “Where can I find meaningful yield without taking on significant or unknown risk in this environment?”
So, how do we discuss that yield vs. risk balancing act with advisors? Let’s step back to the bigger picture and examine how the trade-offs between yield and risk differ for bonds and stocks:
Bonds – With fixed income, the rule of thumb is to take on more credit and/or duration risk in order to seek better yield. Starting at the lower end of the risk spectrum, Treasuries generally have the highest credit rating, and thus are very low on the scale of default risk. Treasuries with very short maturities will have correspondingly low durations, or sensitivity to interest rates. The further out you go in maturity, the more your interest rate risk increases – but the more opportunity there typically is for yield. Similarly, the more credit risk you’re willing to take on – corporate or high yield bonds, for example – the better your chances of income.
The screenshot below from the iShares Fixed Income Portfolio Builder tool illustrates the concept of yield vs. risk in the bond space1. As you can see, the more duration and credit risk you’re willing to take, the more your opportunity for yield increases. In the actual tool, you can select the yield you’re aiming for (say, 2.97% – in exchange for a medium amount of credit risk and a 7 year duration), and it will display a sample portfolio of ETFs that corresponds to your selected criteria.
Equity Income – Some stocks pay dividends, some don’t. The bottom line is that stock dividends have been proven to be too important to ignore. Since 1988, roughly 40% of equity appreciation in the marketplace has come from dividends (both from the income and impact of reinvesting that income on increasing total returns)2. In the short-term, particularly in times of volatility, the relative historical stability of high dividend yielding stocks can make them attractive, as well.
The chart below shows historical periods of negative, low and high GDP growth3. Many pundits, includingiShares Chief Investment Strategist Russ Koesterich, believe we are likely to be in a low growth environment in the near term globally – which, as you can see, has been the best environment for high dividend equities in the past.
Another benefit of high dividend stocks is that they tend to pay well because they are issued by companies that have stable earnings, competitive advantages or other financial strengths – this can translate into lower risk. In addition, dividend stocks tend to be less actively traded, as the steady cash flow and relative maturity of dividend-paying companies can make these stocks more appealing to long-term investors. However, it’s important to remember that dividend equities are still equities, which means they carry more risk than fixed income in general.
As you can see, the hunt for yield is far from a simple thing for both financial advisors and their clients. However, the task can be made easier by the multitude of ETFs available to help fine-tune a portfolio. And with resources like the Fixed Income Portfolio Builder tool that I mentioned above, it’s easier than ever for investors to analyze portfolios which can help them make decisions to meet their income objectives.
Brian Fairhurst, Vice President, is a Business Development Manager for the iShares business within BlackRock. He leads a sales team of Business Development Associates covering advisors within the Core Wires, Registered Investment Advisors, and Private Clients & Institutions channels. Brian joined BlackRock in 2009 as part of its acquisition of Barclays Global Investors, where he was a Business Development Associate.
Brian started out his investment career as a Financial Advisor at Merrill Lynch before moving into the Registered Investment Advisory world. He transitioned to high net worth private client sales and relationship management at Fisher Investments, where he built and maintained a client book of $300mm. Prior to his financial services career, Brian was a Special Operations and Airborne Intelligence Officer in the U.S. Air Force.
Brian received his BA degree in International Relations from the University of Virginia. He currently holds the CIMA® designation.
1. No proprietary technology or asset allocation model is a guarantee against loss of principal. There can be no assurance that an investment strategy based on the tools will be successful. Sample screenshots from the iShares.com website are for illustrative purposes only. Data on any sample screenshot is as of a certain date and there is no representation that it is current, accurate or complete, and it should not be relied on as such.
2. Source Bloomberg, based on oldest data available (1988), as of 12/30/11.
3. Sources: BlackRock, Barclays and Bloomberg. Note: US data only. Economic growth bands determined by inflection points in the growth of US industrial production. Negative Growth Annualized Returns : 10/90-6/91, 6/00-1/02, 9/07-6/09. Low Growth Annualized Returns: 1/86-10/90, 6/91-9/93, 2/95-2/96, 8/02-9/07. High Growth Annualized Returns: 9/93-2/95, 2/96-6/00, 1/02-8/02, 7/09-9/10.
Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. For actual iShares Fund performance, please visit www.iShares.com or request a prospectus by calling 1-800-iShares (1-800-474-2737).
Bonds and bond funds will decrease in value as interest rates rise.