(Skip this part if you are already up to date with my series of articles)
I have been writing a series of articles analyzing the performance of high yield investment portfolios composed primarily of mREITs, BDCs, and CEFs. I started the project after reading articles about high yield investing here on Seeking Alpha which made it sound like a way for a retiree to have twice as much money to safely spend in retirement compared to what he or she would be able to realize through more conventional investment strategies.
I started out in 2015 by constructing model portfolios composed of high yielding securities suggested by WmHilger and High Yield Investor. That first study was made on the model of a retiree who invested his nest egg in the suggested high yield portfolios with $500,000, withdrawing a portion for spending every year and reinvesting the rest of the dividends to grow the portfolio over time. I "funded" two index funds as of July 1, 2010, with the same initial payment and followed the same technique there, except instead of reinvesting extra dividends, I sold off some of the funds each year to meet the spending schedule (because the dividends were less than the amount of the withdrawal.) The withdrawals were 9% of the initial model portfolios - the range that was then suggested was attainable through high yield - plus annual COLA adjustments. I wrote it up in a series of articles, including Can High Yield Investment Portfolios Support Higher Income In Retirement? and Model High-Yield Portfolios Holding BDCs, MREITs And CEFs Fail Multi-Year Performance Tests.
These two charts tell the story of where that led by the end of 2016:
The two high-yield portfolios had entered a death spiral, where the dividends (after having been cut in many cases) no longer covered the withdrawals, let alone had anything left over to reinvest. Even after compounding over the first 5 1/2 years, the total dividend production of the portfolios today would be less than the original amount withdrawn, let alone that plus COLA.
My articles were not well received by those who advocate for high yield. So, I designed another study, and published that earlier this month: High-Yield Investment Strategy Fails. This time, I gleaned 59 investments which had been published in SA portfolios in 2014 by High Yield Investor (50-50) and Steven Bavaria (Savvy Senior Income Factory), as well as Wm Hilger's ten "MRHY" suggestions made the following year. I then analyzed the performance of that static portfolio over the period of May 1, 2014, to July 1, 2018. (May 1, 2014, was the date Steven Bavaria published a list of his portfolio.) The results were underwhelming. 95% of the investments saw a capital loss. Two thirds experienced a cut in their dividend payouts. And the combined creation of wealth from that "buy and hold" portfolio, with dividends received and capital gains or losses added or subtracted - was an annual return of less than 4.7%.
This article was, again, not well received in the high yield community. This time, I had ignored compounding by failing to reinvest the dividends. I had picked an "unfair" time period to study. And one reader noted "the conspicuous absence of any discussion of Left Banker's High Yield, Sustainable Capital portfolio."
Several readers commented that my results did not appear to jibe with the stated results of High Yield Investor and Steven Bavaria. But in fact they did. I was using a static portfolio - no buying and selling allowed. The creators of the high yield portfolios, however, were buying and selling, in many cases avoiding downturns in the value of some of their selections by unloading them before they really cratered. As a result, recently, they have reported seeing overall gains in the vicinity of 40% since the beginning of 2014 - significantly better that I saw from a buy and hold approach applied to their initial reported portfolios. The problem remained that the market as a whole (using the S&P 500 as a proxy for "the market") was gaining around 60% during the same period. I was still not seeing how this helped a retiree spend more, safely, in retirement.
I have carefully weighed the comments and criticisms the thoughtful readers of my previous articles have offered, and this new study is the result.
Study #3 (The new part starts here)
I'm still working on this project. When I have tried to pin down actual, apples-to-apples results from the high yield approach I have found little testable data obscured by a flurry of moving parts - and a lot of explications of high yield theories. I wanted to be able to fairly compare high yield to "the market" to see if it really delivers better results. And I want the results to be as clear, fair, and accurate as possible.
I prefer to compare static portfolios to one which is constantly changing because skill at trading - knowing when to buy and when to sell - is going to be profitable regardless of the market sector it is performed in. A good trader will make money regardless of whether the asset sold is income or growth oriented; a poor one may lose money in a profitable sector. In the 1990s, people made huge profits buying and selling Beanie Babies while real estate values stagnated. I don't think that meant Beanie Babies was a better place for your retirement funds than real estate twenty years ago - unless you knew exactly when to cash in your plush toy collection.
I want to see if the sector itself - here, high yield focused on mREITs, BDCs, and CEFs - is a better place to invest your retirement savings than the average of the market as a whole.
Reader Monopoly Man referred me to Dividend Channel's tool for calculating the total return from a dividend paying stock over a period of time, including reinvestment of those dividends into more shares of the same company. So, by using that tool, I got my compounding problem taken care of. To deal with the "unfair time period" issue, I used the Dividend Channel tool to calculate the total annualized return of each investment since 1995 (or the life of the company, whichever was shorter - it averaged out to 13.65 years.) The S&P 500 performance with its dividends reinvested for that exact same period is also generated as to each investment. There's your time period problem solved; apples to apples for each security, over a wide range of time spans. And I added Left Banker's initial 2016 portfolio into the mix to get even more high yield investments to study. Some companies merged or had other corporate restructuring which prevented me from tracking them, and Dividend Channel had some clear errors in its data which required me to eliminate a few more. Here's the four lists of the ones I analyzed, by source:
|Steven Bavaria, "Savvy Senior Income Factory" May 2014||High Yield Investor, "50-50" portfolio, December 2014|
|Apollo Tactical Income Fund||(NYSE:AIF)||AGNC Investment Corp.||(NASDAQ:AGNC)|
|Ares Multi Strategy Income Fund||(NYSE:ARDC)||Apollo Investment Corporation||(NASDAQ:AINV)|
|BlackRock Multi-Sector Income Trust||(NYSE:BIT)||Ares Capital Corporation||(NASDAQ:ARCC)|
|Calamos Global Dynamic Income Fund||(NASDAQ:CHW)||Apollo Commercial Real Estate Finance, Inc.||(NYSE:ARI)|
|Credit Suisse High Yield||(NYSEMKT:DHY)||UBS ETRACS 2xLvg Lng WF Busn Dev Co ETN||(NYSEARCA:BDCL)|
|Duff & Phelps Global Utilities Income Fund||(NYSE:DPG)||Capstead Mortgage Corporation||(NYSE:CMO)|
|Black Rock Debt Strategies Fund||(NYSE:DSU)||CYS Investments, Inc.||(NYSE:CYS)|
|Wells Fargo Advantage Income Oppty Fund||(NYSEMKT:EAD)||Dynex Capital, Inc.||(NYSE:DX)|
|Wells Fargo Advantage Global Dividend Fund||(NYSE:EOD)||Golub Capital BDC, Inc.||(NASDAQ:GBDC)|
|Eaton Vance Risk Mgd Diversified Equity Income||(NYSE:ETJ)||Horizon Technology Finance Corporation||(NASDAQ:HRZN)|
|Eaton Vance Tax Mgd Global Buy Write Fund||(NYSE:ETW)||Hercules Capital, Inc.||(NASDAQ:HTGC)|
|Eaton Vance Limited Duration||(NYSEMKT:EVV)||Medley Capital Corp.||(NYSE:MCC)|
|Eaton Vance Tax Mgd Global Diversified Income||(NYSE:EXG)||MFA Financial, Inc.||(NYSE:MFA)|
|First Trust Specialty Financial Oppty Fund||(NYSE:FGB)||AG Mortgage Investment Trust, Inc.||(NYSE:MITT)|
|First Trust Strategic High Income Fund||(NYSE:FHY)||UBS ETRACS Mthly Py 2xLvg Mortg REIT ETN||(NYSEARCA:MORL)|
|Cohen & Steers Closed End Opportunity Fund||(NYSE:FOF)||Annaly Capital Management, Inc.||(NYSE:NLY)|
|Oaktree Specialty Lending Corp||(NASDAQ:OCSL)||New Mountain Finance Corp.||(NYSE:NMFC)|
|Western Asset High Income Fund||(NYSE:HIX)||New York Mortgage Trust, Inc.||(NASDAQ:NYMT)|
|John Hancock Pref Income||(NYSE:HPI)||Oaktree Specialty Lending Corp||(OCSL)|
|ING Global Advantage Fund||(NYSE:IGA)||Resource Capital Corp.||(RSO)|
|Nuveen Preferred Income Oppty Fund||(NYSE:JPC)||Stellus Capital Investment Corporation||(NYSE:SCM)|
|Nuveen Real Asset Income & Growth||(NYSE:JRI)||Solar Capital Ltd.||(NASDAQ:SLRC)|
|Medley Capital Corp.||(MCC)||Starwood Property Trust, Inc.||(NYSE:STWD)|
|Allianz NFJ Dividend Interest & Premium Strategy||(NYSE:NFJ)||TCP Capital Corp.||(NASDAQ:TCPC)|
|New Mountain Finance Corp.||(NMFC)||THL Credit Inc.||(NASDAQ:TCRD)|
|Oxford Lane Capital Corp.||(NASDAQ:OXLC)||Two Harbors Investment Corp.||(NYSE:TWO)|
|Pimco Dynamic Credit Income Fund||(NYSE:PCI)||Western Asset Mortgage Capital Corporation||(NYSE:WMC)|
|Pennant Park Investment Corp.||(NASDAQ:PNNT)|
|Prospect Capital Corp.||(NASDAQ:PSEC)||Left Banker "High-Yield, Sustainable-Capital Income portfolio" September 2016|
|Seadrill||(NYSE:SDRL)||Western Asset Mortgage Defined Opportunity Fund Inc.||(DMO)|
|THL Credit Inc.||(TCRD)||Eaton Vance Municipal Bond Fund||(EIM)|
|Third Avenue Focused Credit Fund||(TFCIX)||Eaton Vance Tax Mgd Global Buy Write Fund||(ETW)|
|Eaton Vance Tax-Managed Diversified Equity Income Fund||(ETY)|
|WmHilger1 sample of "MRHY" June 16, 2015||Flaherty & Crumrine Preferred Securities Income Fund Inc.||(FFC)|
|Arlington Asset Investment Corp.||(NYSE:AI)||Five Point Holdings, LLC||(FPF)|
|Calumet Specialty Products Partners, L.P.||(NASDAQ:CLMT)||Tekla Healthcare Investors||(HQH)|
|Ellington Financial LLC||(NYSE:EFC)||MFS Municipal Income Trust||(MFM)|
|Horizon Technology Finance Corporation||(HRZN)||AllianzGI Convertible & Income Fund||(NCV)|
|Medley Capital Corp.||(MCC)||PIMCO Dynamic Income Fund||(PDI)|
|Resource Capital Corp.||(RSO)||Nuveen Nasdaq 100 Dynamic Overwrite Fund||(QQQX)|
|KCAP Financial, Inc.||(NASDAQ:KCAP)||PIMCO Strategic Income Fund, Inc.||(RCS)|
|Pennant Park Investment Corp.||(PNNT)||Cohen & Steers Total Return Realty Fund, Inc.||(RFI)|
|Western Asset Mortgage Capital Corporation||(WMC)||Columbia Seligman Premium Technology Growth Fund||(STK)|
As you can see, many of the choices appear on more than one list; those are bolded. I ended up with a total of 69 different companies to compare to the market after eliminating duplicates.
- 15 of the high yield investments outperformed the S&P 500. None of them was selected by more than one source.
- 54 of them underperformed the S&P 500. Eight of them were selected by two or more sources.
- 7 had a net loss - the sum of their dividends and current share price is less than they cost when issued. One of those was selected by three sources.
- The average return on the 69 high yield investments was 6% per year.
- The average return from the S&P 500 in the corresponding time periods was 9.8% per year.
- Due to survivor bias, of the high yield companies reviewed, those which have been in existence for over 20 years underperformed the market by a narrower margin than newer ones.
And here's a chart showing the distribution of performance vs. S&P 500 and the length of the period:
As you can see from the trend line, the average underperformance of the high yield investments averages about 30% for the ones that have been around for 20 years or more, while the newer ones underperform by an average of over 40%. That's to be expected due to survivor bias; the worst of the companies in 1995 wouldn't be around in 2014-2016 to be chosen, so the further back you go, you should expect higher average quality of the ones that are still around. As an example, the worst performer in the study - SDRL - only appears in the oldest list, generated in May 2014. By the end of 2014, no one was putting it on a list of suggested investments anymore.
And note: the set of high yield investments studied was limited to securities recommended by writers who support high yield investment strategies.
So, what does that mean? Well, it means different things at different points in your retirement portfolio's lifespan, which is composed of two primary periods: the accumulation phase, where you're saving and investing the extra cash you have left over from whatever you do to pay your bills, and the distribution period, when you start spending the money in that account because you're no longer working.
A lot of the discussion of high yield strategy conflates those two periods. But that's a mistake.
During your accumulation phase, nothing matters except the net value of your portfolio at the end of that period. Literally nothing. It doesn't matter how you get there - reinvesting high yield dividends, DGI, pure growth stocks, winning the lottery. How you get there doesn't matter, what matters is the size of your portfolio the day you retire. The reason for that is simple: when the accumulation period comes to an end, you can sell everything you hold in your portfolio and convert it to cash. (If it's not in a tax-deferred account like an IRA this could trigger tax consequences, but only to the extent that you have unrealized capital gains.) If there's a different strategy you want to follow after you retire, you can implement that then. So, it's clear to me that total value is the only metric which applies to investing in your accumulation years.
By that standard, high yield clearly fails. If you had invested $5,000 in each of the investments listed in this study, either in 1995 for the oldest companies or later, when the rest first issued shares, and your clueless buddy Stan had dumped $5,000 into an S&P 500 index fund at the same time, matching you dollar for dollar, and you both reinvested all of your dividends, you'd have had about $974,000 in your retirement next egg when you retired at the beginning of this month. Stan, on the other hand, would have over $1.2 million in his.
(And for those of you who think I'm cheating by using the S&P 500, it actually has worse performance than a Russell 2000 index fund (IWM +53%) a Wilshire 5000 fund (WMCR+27%). If you are convinced that high yield is the way to go in your distribution phase, you can buy your high yield investments when you retire. You don't need to use it to build your nest egg, and given the results of this study, trying to do so would appear to be a bad choice. "Editors' note: This article previously cited an incorrectly calculated return for NOBL from an outside source. The reference has been removed."
Here's where I hear the sad refrain that "I can't live on 4% of my savings each year, so I need to get 8% (or 9%, or 10%, or more). That is the explicit basis for High Yield Investor's decision to craft a high yield portfolio:
"The bottom line was to come up with the income you need from your retirement portfolio." 50/50 Portfolio (BDCs And mREITs) Baseline, 2014
But here's the problem with using a portfolio composed of mREITs, BDCs, and CEFs that pay an average of 10% (or more) as the means to that end: the dividends not only don't grow over time, they get reduced. Steven Bavaria is candid about this:
"I don't believe I can ever know for sure where dividend cuts are going to occur, no matter how much attention I pay to what management tells us or reports in its financial statements." Dividend Cuts
Dividend reductions are the rule, not the exception. In my last study, I found that 40 of the 59 securities studied experienced a dividend reduction or elimination in the 50 months of the study, and the average dividend payout (including the handful which increased and those which remained stable) declined by 25% during that period. Of the 19 stocks in that study which did not reduce dividends during that four-year window, nine had reduced them in the years leading up to it. Of the remaining 10, eight were less than nine years old.
The combined dividend payout of the 20 securities used in my first study declined by 45% between 2010 and 2018, with all but three being reduced during that time period. And look back at the first chart in this article which depicts how a 9% withdrawal from two high yield portfolios was in failure mode after just 5 1/2 years, even using reinvested dividends in the early years.
Dividend reductions are not one-time events, and you can't solve the problem by diversifying your portfolio - almost all of the high yield securities studied that had been in existence for more than a decade saw a dividend reduction at some point over the course of the past 10 years. The average of a 5% yearly decline in dividend payments seen in both studies may not be a problem year 1, but if in year 10, your income stream has been cut in half, you'll be in a world of hurt.
I said high yield investment strategy fails. It does, as tested in static portfolios with dozens of recommended holdings compared to the general stock market over multiple time periods, including reinvestment of dividends. I believe that that is a fair apples-to-apples test.
But what about an actively managed portfolio? It may be possible to do better than the static investing I have portrayed by actively buying and selling - as long as you are smarter than the market is and make the right decision most of the time. (And when you're making that decision to buy or sell, remember - there's a person on the other side of the transaction. Are you sure you're smarter and better informed than he or she is?)
The authors who write articles on Seeking Alpha about high yield investing are very smart, and they work hard at what they are doing. They have been actively managing their portfolios all along, and I believe them when they report their recent results. But consider how their portfolios have performed compared to the return of the SPDR S&P 500 ETF (NYSEARCA:SPY):
High Yield Investor states in his most recent article that his overall return on his 50-50 portfolio from the beginning of 2014 to July 2018 was 41%.
SPY's return over that same period with dividends reinvested was 62%.
Steven Bavaria reports that his Savvy Senior Income factory total return was -2% for 2014-2015, +20% in 2016, +20.6% in 2017, and -2.8% in Q1 2018 for a total of about 39% from the beginning of 2014 to April 2018.
SPY's return over that same period with dividends reinvested was 57%.
Left Banker reports that for his High-Yield, Sustainable Capital, Income Portfolio since September 2016: "When cash flow to current income is accounted for, the internal rate of return is 13.47%"
SPY's rate of return over the same period was 15.32%
These are the guys who are writing the articles. If they can't beat the return from the most boring index fund in America over a period of several years, it must be because the strategy itself doesn't actually work as advertised. And indeed, their actively-managed portfolios trail SPY in a manner which is consistent with the long-term underperformance of the high yield investments vs. the S&P 500 that I found when I performed this study.
As I've stated before, there can be a role for some high yielding investments in a retirement portfolio. Carefully selected fixed income assets can help create an income flow designed for a retiree's specific financial circumstances. But wholesale reliance on high yielding CEFs, mREITS, LLPs and BDCs won't magically generate a safe means of spending more in retirement. They are more likely to trick you into believing you can spend more than is safe and leave you in the lurch down the road.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.