What are the risks of alternative yield-seeking strategies?
Q: What are the risks of alternative yield-seeking strategies?
A: Replacing a portion of your high-quality bond or bond mutual fund holdings with strategies ranging from high-dividend stocks to oil-and-gas master limited partnerships because “rates are low” involves taking on substantially more risk. A more efficient way to increase your level of risk is to increase your allocation to a diversified, low-cost stock fund portfolio.
The simplest way to get a sense of the risk that accompanies these strategies is to look at their performance when the stock market has done poorly. The first table shows the performance of high-dividend stocks, preferred stocks, oil-and-gas master limited partnerships and high-yield corporate bonds during the three most recent quarters when the stock market performed poorly.
|
High-Dividend Stocks |
Preferred Stocks |
Master Limited Partnerships |
High-Yield Corporate Bonds |
|
| 4th Quarter 2008 |
–21.3 |
10.3 |
–20.3 |
–17.9 |
| 1st Quarter 2009 |
–23.1 |
–19.2 |
11.2 |
6.0 |
| 3rd Quarter 2011 |
–8.0 |
–7.6 |
–7.0 |
–6.1 |
This table shows that high-dividend stocks were down more than 21 percent in the fourth quarter of 2008. On average, these strategies lost almost 9 percent during these quarters when the stock market did poorly. This isn’t surprising because each strategy has direct exposure to the stock market or contains stock-like risks.
A more useful analysis is to compare how each strategy did relative to U.S. Treasury bonds over these same quarters. This gives a sense of the additional risk an investor in these strategies would have experienced relative to high-quality fixed income.
|
High-Dividend Stocks |
Preferred Stocks |
Master Limited Partnerships |
High-Yield Corporate Bonds |
|
| 4th Quarter 2008 |
–30.1 |
1.5 |
–29.1 |
–26.7 |
| 1st Quarter 2009 |
–21.8 |
–17.9 |
12.5 |
7.3 |
| 3rd Quarter 2011 |
–14.5 |
–14.1 |
–13.5 |
–12.6 |
Each negative number represents underperformance relative to U.S. Treasury bonds, making the risk of these strategies apparent. On average, these strategies underperformed high-quality fixed income by more than 13 percent in these periods. This demonstrates that these strategies do not provide the diversification and risk-reduction benefits of high-quality bonds, and that they are more like stocks than high-quality bonds.
Data from following sources: high-dividend stock, Kenneth French’s data library (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/); preferred stocks and master-limited partnerships, Bloomberg; high-yield corporate bonds, Barclays Capital Live.
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