High Yield Fails In A Down Market, Too

Includes: FOF, LADR, NOBL, PMT
by: Steve Condie

Previous studies showed that portfolios composed of high-yield CEF, mREIT and BDC investments underperformed in the long bull market of the past decade.

2018's down market provided an opportunity to see how the high yield portfolios fared in a down market.

The high yield portfolios underperformed the market overall during the downturn in 2018 as well.


After reading a series of articles and posts touting investment in high yield BDCs, CEFs and mREITS in 2014, I decided to study how those investments performed relative to the overall market, using the index fund SPDR S&P 500 ETF (NYSEARCA:SPY) as a proxy for "the market." Last July I wrote up the results of that investigation in a series of articles which found that:

1. Two-thirds of the high yield securities chosen or recommended by proponents of the high yield investment philosophy in 2014 cut their dividends over a period of 50 months (May, 2014 through July, 2018).

2. 95% of those selected securities saw a loss of equity value in that same time period.

3. A static portfolio of the recommended securities held throughout that period which supposedly "yielded" over 10% had an actual yield of just 4.7% when equity loss was taken into consideration. (See High-Yield Investment Strategy Fails)


4. Studying dozens of investments using multiple measures, static "buy and hold" high yield portfolios underperformed the market by 40% over extended time periods, including dividends.

5. Actively managed high yield portfolios typically underperformed the market by about 30% over time, including dividends. (See High Yield Strategy Fails Again and 2007-2018 DGI Vs. HYI Vs. Index Fund)

The conclusion was clear: The "high yield" promised by investments which tout payouts of 10% (and more) is generally illusory. In effect it was primarily the investors' own money being returned to them in the guise of "yield" with the concomitant loss of value of his investment. The actual performance of this sector of the market was sub-par during the period of generally rising values.

But all that took place in a background of generally rising values in the market. Several commenters opined that that consistent pattern would not hold true in a market downturn. After I wrote those articles in July, however, the market took a turn for the worse.

How did the high yield investments hold up in the down market from August to year end, 2018?

Not any better than they did in the previous bull market.

In the last five months of the year SPY lost 10%. For the full year (December 31, 2017 through December 31, 2018) SPY was down 4.4% (including dividend income.) For comparison:


Cohen & Steers Closed-End Opportunity Fund, Inc. (FOF) is a valid proxy for high yield investments in this sector in general. It is a professionally managed "fund of funds" which holds various high yield instruments including CEFs, BDCs amd mREITS (see Steven Bavaria's article discussing FOF). I previously found that the performance of FOF consistently trailed that of the SPY going up; that held true in 2018. Going down: for the full year FOF was down 8.8% vs. SPY's 4.4% loss. In the last five months of 2018, FOF showed a loss of 12.8% vs. 10% down for SPY.

Income Factory

Steven Bavaria reports that his high yield portfolio lost a net 9.8% for the year after offsetting capital losses with dividends.


In August, High Yield Investor wrote that his "50-50" portfolio was up 7.46% for the year on after seven months of 2018. HYI's year end report showed a year-end net loss of 2.93% five months later, for a loss over that time frame of 10.4% That's pretty respectable compared to the other high yield portfolios. (It's worth noting that HYI's full year performance was significantly aided by outperformance of two of the lower-yielding investments in the portfolio in the first half of the year: Ladder Capital Corp (LADR) and PennyMac Mortgage Investment Trust (PMT) were each up more than 20% in the first seven months of 2018 before falling back.)

8% Income Portfolio.

Although it's not as aggressive as the others, Financially Free Investor's 8% Income Portfolio has a significant overlap with the more aggressive high yield portfolios reviewed previously. Further, it is presented as a part of a three-bucket portfolio philosophy, rather than a total investment strategy. FFI reports that the 8% income portfolio lost 5.74% including dividend income for 2018 vs. SPY's -4.4% over the same period.

How about DGI?

ProShares S&P 500 Dividend Aristocrats (NOBL) a dividend aristocrat fund, lost 3.3% in 2018 and 5.4% during the last five months of the year, beating SPY on both counts.


Some valid conclusions can be drawn from my examination of the high yield CEF, mREIT and BDC investment portfolios I have studied.

  1. I believe we owe each of the referenced Seeking Alpha authors sincere thanks for their contributions to the conversation about "seeking alpha." Whether you agree or disagree with their conclusions, by rigorously reporting their results on a regular basis, their transparency allows critical examination of the pros and cons of their approaches. That stands in stark contrast to the many hucksters inhabiting the public arena who tout huge profits without ever providing the background data required to assess the validity of their claims.
  2. Having said that, I find that the articles written by proponents of high yield investing tend to be long on flowery (and at times fiery!) language and the specific data needed to analyze the actual performance of the approach can be hard to find in the lengthy discussions of a philosophical nature which can obscure the actual sub-par performance of the sector.
  3. The reality is that high yield CEFs, mREITs and BDCs, as a group, underperform the market as a whole over time when all is said and done. When the market as a whole was going up, they went up, but not as far as the rest of the market. When the market went down, they went down further.

That doesn't mean that every high yield security will underperform the market in every time frame. It does mean that a blind faith that investing exclusively in that sector will allow the retiree who "hasn't saved enough" to spend more than he or she could safely spend if they invested using a more conventional strategy is misplaced. The truth is just the opposite. You will go broke faster overspending from a high yield portfolio than you would from a DGI portfolio or index fund.

I'm not here to push any specific investment philosophy. I don't advocate buying SPY (I don't own it) although for some people at some stage of their lives it might be a good idea. I don't advocate investing exclusively in CDs (although I have written an article about that.) Nor do I espouse investing in NOBL or exclusively in DGI stocks in general. (I don't, although in the past I have done so.) Each person's "ideal" investment portfolio has to be crafted in response to that person's financial and personal circumstances at a given time.

I read Seeking Alpha articles to get ideas for further research and investigation in order to make my own decisions about my own investments. Sometimes the lesson to be learned is that a touted investment strategy actually doesn't perform as well as its advocates claim.

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.

Additional disclosure: Over the past two years I have transitioned from being 90+% invested in DGI stocks to having a majority of my portfolio invested in cash, CDs, bonds and preferred stocks. The common stocks I continue to hold are primarily telecon, utilities and eREITs. I was (marginally) in the black for 2018 and my annual return over the past five years averages 1% per year higher than the return from the S&P500.