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Hey! What happened to my income?

July 31, 2013
by Kal
active investing, Global investing, managing risk
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Corp Bond Yield ChartIn this low interest rate environment, income recipients have been feeling the pain.  We were approached last week by a client who is an income-only beneficiary of a trust.  He was considering more yield-oriented investments to increase his income.  We made the following points:

  • This is a monthly chart of high quality corporate bond yields going back to 1919.

 

  • All market interest rates have generally tracked it.

 

  • Your bond portfolio yield, and thus your income, has followed the pattern.

 

  • The last 12 months income levels have been the lowest since the late 1950s.

 

  • You are not alone: US income recipients have seen their incomes hit very low levels.

 

  • In percentage terms, the drop has been significant – 33% from pre-Credit Crisis levels.

 

  • Recent circumstances have been very unusual – as demand for bonds has been abnormally high.

 

  • Sources of this demand include fearful investors, banks needing riskless capital and the Fed’s efforts to stimulate growth.

 

  • These sources of demand have pushed bond prices to unprecedented levels of overvaluation.

 

  • Such extremes can tempt investors into counterproductive behavior.

 

  • They can tempt them to act in a manner that is contrary to what a patient, total return-oriented investor should do.

 

  • We expect current yields to eventually recover to more normal levels, with that 33% income drop being recouped over the next few years.

 

  • June’s jump in yields took them back up to their lows of 2010, indicating the process has already started.

 

  • Note the recent move in yield from 3.7% to 4.3% is an income increase of 16%.

 

  • As abnormally high bond demand falls away, we expect this yield to eventually reach 5.5%.

 

  • This will mean a significant increase in your income and the loss of windfall price gains of recent years.

 

  • All income producing investments, whether they are marked-to-market or not, will behave like bonds and lose economic value when interest rates rise.

 

  • We advise you to not add to bonds or seek higher yielding investments at this time.  Your efforts would come at the expense of your portfolio strategy.

 

  • Our approach is to always manage the portfolio from a total return perspective in the current and expected investment environments.

 

  • We believe our approach will give you a high probability of growing income.

 

About the Author
At The Headlands Group, we are committed to making high probability of success investors. We transform client concerns about financial markets into the confidence that comes from knowing their investing experience will be a successful one. If we can succeed in getting clients to avoid “easy and popular” and allowing us to do “difficult and unpopular” on their behalf, we have made them into the “house” at the market casino and improved the odds that they will be successful over their investing lifetimes. We believe our clients perform better than most large institutions – despite not having the same investment resources.
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