Traditional investment grade bonds will probably not produce the returns most investors need to reach their retirement goals, however, there are other options available. As many who have read our previous commentaries are aware, we’ve found the risk reward tradeoff in preferred stocks attractive. The year-to-date return for the S&P U.S. Preferred Stock Index is 7.02%, with its 10-year average annualized return equal to 4.97%. Most of this return is attributable to the dividends paid by the preferred stocks, making them a fairly predictable source of income. We have also found value in certain Asset Backed bonds, which have provided returns like what we’ve found in preferred stocks. Also under the umbrella of fixed income, we have found a stable source of value in High Yield Municipal Bonds. The Bloomberg Barclays Municipal Index has generated 4.78% per year over the last 10 years. We prefer the high yield muni space over corporate high yield because the default rate among high yield municipal bonds, as reported by Moody’s is about 8.2% versus 29.4% for high yield corporate bonds.
We’ve also found sources of income in equities and master limited partnerships (typically energy related). The S&P 500 currently pays about 2% in dividend income, and dividends between 4% and 7% are commonly available in Master Limited Partnerships. Another method we’ve been using to increase income in some portfolios is Covered Call Writing. This is selling someone else the right to purchase stock held in your account for a predetermined amount. The benefit to clients is that we can typically earn an additional 3% to 5% in yield above and beyond what the stock is paying in dividend income. While investors are accepting higher levels of volatility in equities, master limited partnerships, and options - they are also earning an attractive income with the possibility of capital appreciation, which is unexpected in fixed income investments at today’s prices.
By mixing and matching a various income producing investments, we can help meet investors’ demand for income, even in this low interest rate environment. We believe meeting our clients’ income needs will help reduce the long-term structural risk of investing because it will allow more principal to stay invested for longer periods of time. One of our core beliefs is what matters most in investing is “time in the market,” not “timing the market.”
