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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.

Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

 

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