Lower Risk, Higher-Yield Portfolios Of Funds

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Includes: ACWV, BIAEX, FFFAX, FPNIX, FSDIX, FSREX, FXIMX, LMBS, MINT, MSTDX, PGHY, RYU, SPLV, SPYD, VMNVX, VTABX, VWAHX, VWIAX
by: Charles Bolin
Summary

Portfolios of funds with lower risk and with higher yields are constructed for retirement income.

Three Model Portfolios have average annual returns of 5.7% to 9.8% during the past three years with yields of 2.5% to 3.0%.

The maximum drawdown is 1.4% to 5.2% compared to 13.5% for the S&P 500 for the past three years based on monthly returns.

A link to Portfolio Visualizer is provided so that readers can adjust the Model Portfolios to their preferences and risk tolerance.

Finally, while I've often argued that retirees shouldn't prioritize income production because it can lead them into risky territory, I do think yielders can work well as part of the Bucket approach. As a retiree spends from Bucket 1 (cash for ongoing living expenses), he or she can refill it, at least partially, with current income distributions. If those distributions are insufficient to refill Bucket 1 entirely, rebalancing proceeds can make up the difference. What Do the Bucket Portfolios Yield?, Morningstar By Christine Benz

The above article then goes on to say that three Morningstar Mutual Fund Bucket Portfolios are yielding about 2.7%.

Introduction

Portfolio Visualizer is a great tool for backtesting portfolios on a pre-tax basis, but doesn't include target yields for income, nor the tax efficiency of the portfolio. For this article, I screened mutual funds and exchange traded funds for each Lipper Category using Mutual Fund Observer. Criteria was risk (Ulcer Index), risk-adjusted returns (Martin Ratio), and dividend yield.

I then used Portfolio Visualizer to create three portfolios with varying amounts of volatility (standard deviation). Below are Lipper Categories selected using my constraints and personal preferences. Top Funds based on risk, risk-adjusted returns, and risk-adjusted yields are shown below. The complete list can be found in this attachment: High_Risk_Adjusted_Yields. I divided the yield by the Ulcer Index to show the yield for the risk taken.

Metrics Top Funds
Avg Yield Yield/Ulcer 1 2 3
Very Conservative
Ultra-Short Obligations 2.5 GSY MINT VUSFX
Short-Intmdt Invest Grade Debt 2.7 21.5 MSTDX SDMQX FTSM
Municipal Interm Debt 2.4 7.8 BIAEX HMOP VWITX
U.S. Mortgage 2.7 6.8 LMBS MBG VMBS
Munic Gen & Insured Debt 2.8 6.2 FXIEX VWAHX VTEB
Multi-Sector Income 3.6 10.3 FXIMX FXICX RIGS
International Income 2.3 6.9 IAGG VTABX FIBZX
Conservative
Alternative Credit Focus 4.5 3.8 FPNIX BLHY
High Yield 5.3 6.3 PGHY HYSZX SHYG
Mxd-Asst Target Alloc Consv 2.3 1.9 VWINX VASIX FSRRX
Mixed-Asset Target Today 2.0 1.8 FFFAX
Moderate
Utility 2.5 2.2 RYU FSUTX VPU
Global Multi-Cap Core 2.1 0.8 ACWV
Global Small-/Mid-Cap 2.2 0.7 VMNVX
Aggressive
Equity Income 3.4 1.2 SPYD SPHD FDL
Multi-Cap Core 2.0 0.9 SPLV

Source: Created By the Author Based on Mutual Fund Observer and Morningstar

Draw Down Versus Income

Chart #1 is the Efficient Frontier for funds that had a higher yield than the S&P 500 during the last bear market (2007 to 2009). Only bond funds did well. By comparison, the S&P 500 lost 21.8% on an annual basis which was worse than about 85% of the higher yielding funds. High-Yielding bond funds such as Vanguard High Yield Corporate Bond Fund (VWEHX) also lost a small percentage, but fared better than high dividend stocks. Higher dividends provided little protection for stocks.

Chart #1

Source: Created By the Author with Portfolio Visualizer

For me, capital preservation is more important than income during a severe bear market. These Model Portfolios attempt to provide lower drawdown and higher returns, the best of both worlds. Vanguard Intermediate-Term Treasury (VFITX) returned nearly 9% on an annual basis during the 21-month period shown in the Efficient Frontier. It currently has a yield of 2.2%.

Chart #2 shows the fund universe loaded into Portfolio Visualizer for the time period November 2015 through March 2019. Each recession is different, so I prefer using recent metrics from Mutual Fund Observer and Portfolio Visualizer to get an idea how they will behave in the next major bear market.

Chart #2

Source: Created By the Author with Portfolio Visualizer

Chart #3 shows how the same funds have performed during the past 15 months when stocks went through a mild bear market.

Chart #3

Source: Created By the Author with Portfolio Visualizer

The Funds

The Funds selected as lower risk, higher risk-adjusted return, higher yield funds are shown below.

Symbol Name Lipper Category
LMBS First Trust Low Duration Opportunities U.S. Mortgage
MSTDX MassMutual Premier Short Bond Short-Intmdt Invest Grade Debt
FPNIX FPA New Income Alternative Credit Focus
MINT PIMCO Enhanced Short Maturity Ultra-Short Obligations
BIAEX Brown Advisory Tax Exempt Bond Inv Municipal Intermediate Debt
PGHY Invesco Global Short Term Hi Yield Bond High Yield
VWAHX Vanguard High-Yield Tax-Exempt Inv Muni Gen & Insured Debt
VTABX Vanguard Total International Bond International Income
FSREX Fidelity Series Real Estate Income Real Estate
FFFAX Fidelity Freedom Income Mixed-Asset Target Today
FXIMX PIMCO Fixed Income SHares Multi-Sector Income
RYU Invesco S&P 500 Equal Weight Utilities Utility
VWINX Vanguard Wellesley Income Mxd-Asst Target Alloc Consv
SPYD State Street Portfolio S&P 500 Hi Div Equity Income
SPLV Invesco S&P 500 Low Volatility Multi-Cap Core
ACWV BlackRock iShares Edge Min Vol Global Global Multi-Cap Core
VMNVX Vanguard Global Minimum Volatility Global Small-/Mid-Cap
SPY State Street SPDR S&P 500 S&P 500 Index

From Morningstar, the table below shows how the funds are rated and have performed. Most funds have an Analyst Rating of Bronze or higher (not shown).

Symbol Category Rating %Rtn 3 Mon %Rtn 12 Mon STDEV %SEC Yld
ACWV World Large Stock 4 10.1 9.2 8.2 2.1
BIAEX Muni Nat Interm 4 2.6 5.2 2.6 3.1
FFFAX Trgt-Date Retire 3 4.6 3.1 2.9
FPNIX Short-Term Bond 3 1.3 3.1 0.6 3.4
FSREX Real Estate 3 7.1 9.6 3.9 5.2
FXIMX Multisector Bond 4 3.0 5.7 4.2
LMBS Short-Term Bond 4 1.1 2.6 1.0 2.8
MINT Ultrashort Bond 4 1.1 2.5 0.3 2.8
MSTDX Short-Term Bond 4 1.7 3.4 0.7 3.1
PGHY High Yield Bond 3 4.3 4.4 2.2
RYU Utilities 4 9.9 20.9 10.3 2.9
SPLV Large Blend 4 13.5 14.6 9.4
SPY Large Blend 4 13.5 9.4 10.7 2.0
SPYD Large Value 4 12.1 10.6 10.0 4.4
VGSIX Real Estate 3 17.5 19.9 13.8 2.7
VMNVX World Small/Mid Stock 4 10.7 9.2 7.4
VTABX World Bond 4 3.1 5.2 2.5 0.8
VWAHX Muni Nation Long 4 3.5 5.8 4.0 3.0
VWINX Alloc 30 to 50% Eq 4 7.2 6.6 4.3 3.2

Source: Created By the Author Based on Morningstar

The table below is based on data from Mutual Fund Observer. The Ulcer Index is a measure of the length and duration of draw downs. The Martin Ratio is a measure of Risk-Adjusted Returns. I read about how corporate bonds have become riskier as corporations increase the amount of debt. I believe this to be true, but also believe that bonds will fare better than stocks in a recession. These portfolios are biased toward higher quality, intermediate-term debt.

Symbol Lipper Category MAXDD% Ulcer Martin Rating
Very Conservative
LMBS U.S. Mortgage -0.1 0.0 14.3 5
MSTDX Short-Intmdt Invest Grade Debt 0.0 0.0 5
FPNIX Alternative Credit Focus 0.0 0.0 5
MINT Ultra-Short Obligations 0.0 0.0 5
BIAEX Municipal Intermediate Debt -0.7 0.2 9.8 5
PGHY High Yield -1.0 0.4 1.8 4
VWAHX Muni Gen & Insured Debt -1.5 0.5 4.3 4
VTABX International Income -0.3 0.1 25.2 5
FXIMX Multi-Sector Income -0.6 0.2 14.5 5
Conservative
FSREX Real Estate -2.8 0.9 7.0 5
FFFAX Mixed-Asset Target Today -2.4 1.1 -0.5 2
RYU Utility -3.6 1.1 17.7 5
VWINX Mxd-Asst Target Alloc Consv -3.0 1.2 2.0 5
Moderate
ACWV Global Multi-Cap Core -6.6 2.5 2.0 5
VMNVX Global Small-/Mid-Cap -8.2 3.0 1.9 5
Aggressive
SPYD Equity Income -8.7 2.7 2.7 5
SPLV Multi-Cap Core -6.9 2.2 4.9 5
SPY S&P 500 Index -13.5 5.2 0.5 4

Source: Created By the Author Based on Mutual Fund Observer

Charts #4 through #7 show how the funds by Risk Category have performed.

Chart #4

Source: Created By the Author Based on Portfolio Visualizer

Chart #5

Source: Created By the Author Based on Portfolio Visualizer

The two Moderate Risk funds in Chart #6 are Global. One US Equity Funds with a Moderate Risk Rating that appeals to me is Fidelity Strategic Dividend & Income (FSDIX).

Chart #6

Source: Created By the Author Based on Portfolio Visualizer

Chart #7

Source: Created By the Author Based on Portfolio Visualizer

Model Portfolios

I created three model portfolios based on maximizing the Sharpe Ratio (25% stock) or maximizing returns at 5% (50% stock) and 7% (70% stock) volatility, using constraints based on my personal preferences. I compare these to the Fidelity Four-in-One Index fund (FFNOX) which is an aggressive, balanced fund of funds and to the Vanguard Wellesley Income Fund (VWIAX) which is a more conservative fund. Each month $3,333 (approximately 4%) is withdrawn from the four Portfolios. I build my Bucket Approach around the Mutual Fund Observer Risk Classification to avoid concentration and maintain diversification.

The Fidelity® Four-in-One Index Fund has an allocation of 48% to the S&P 500, 12% Dow Jones U.S. Completion Total Stock Market Index, 25% MSCI EAFE Index, and 15% Bloomberg Barclays U.S. Aggregate Bond Index.

Chart #4 contains the three model portfolios compared to the aggressive Fidelity Four-in-One Index fund (FFNOX) and the conservative Vanguard Wellesley Income Fund (VWIAX). During a recession, the 25% Stock Portfolio is likely to outperform the other four. For an investor looking for a long-term buy and hold portfolio of low risk funds with higher dividends then something along the lines of the 50% Stock Portfolio may be more appropriate.

Interested Readers can change allocation in the Portfolio Visualizer Backtest Tool to test their own preferences through this link.

Chart #8

Source: Created By the Author Based on Portfolio Visualizer

Below are the allocations to the funds for each of the Model Portfolios along with the dividend yield and Tax Cost Ratio. The dividend yield is the SEC Yield from Morningstar, and if it was not available then the trailing 12-month yield was used. Morningstar's description of the 3-Year Tax Cost Ratio is shown below.

This [3 Year Tax Cost Ratio] represents the percentage-point reduction in an annualized return that results from income taxes. The calculation assumes investors pay the maximum federal rate on capital gains and ordinary income. For example, if a fund made short-term capital-gains and income distributions that averaged 10% of its NAV over the past three years, an investor in the 35% tax bracket would have a tax cost ratio of 3.5 percentage points.

25% Stock 50% Stock 70% Stock Div Yield Tax Cost Ratio
Very Conservative
BIAEX 10% 2% 0% 3.1% 0.0%
FPNIX 4% 0% 0% 3.4% 1.2%
FXIMX 5% 5% 0% 3.9% 2.1%
LMBS 10% 10% 10% 2.6% 1.1%
MINT 10% 0% 0% 2.5% 0.8%
MSTDX 9% 0% 0% 3.1% 1.2%
PGHY 5% 5% 0% 5.4% 2.4%
VTABX 10% 10% 10% 0.8% 1.0%
VWAHX 0% 5% 0% 3.0% 0.0%
Conservative
FFFAX 15% 0% 0% 2.0% 1.3%
FSREX 0% 5% 0% 5.2% 2.5%
RYU 2% 5% 5% 2.7% 0.9%
VWINX 0% 15% 15% 3.1% 1.6%
Moderate
ACWV 0% 0% 15% 2.1% 0.6%
VMNVX 6% 0% 0% 2.2% 1.2%
Aggressive
SPLV 8% 15% 15% 2.0% 0.7%
SPY 0% 8% 15% 1.9% 0.8%
SPYD 6% 15% 15% 4.3% 1.9%
Metrics
Average Return 5.7% 8.6% 9.8%
STDEV 2.7% 5.1% 6.6%
Sortino Ratio 3.3 2.7 2.2
Draw Down -1.4% -3.5% -5.2%
Yield 2.7% 3.0% 2.5%
Tax Cost Ratio 1.1% 1.3% 1.1%

Source: Created By the Author Based on Portfolio Visualizer

Diversification And Exposure

The next three tables show that while the portfolio does attempt to increase yield, the portfolios are well-diversified.

Allocation

Category 25% Stock 50% Stock 70% Stock
US Stocks 20% 48% 63%
Intl Stocks 5% 1% 8%
US Bonds 52% 35% 16%
Intl Bonds 18% 15% 12%
Other -7% -6% 0%
Cash 12% 7% 2%

Source: Created By the Author Based on Portfolio Visualizer

Bond Quality

Category 25% Stock 50% Stock 70% Stock
AAA 45% 29% 42%
AA 10% 12% 14%
A 19% 25% 29%
BBB 15% 15% 14%
Non-Investment Grade 9% 14% 0%
Not Rated 2% 4% 1%

Source: Created By the Author Based on Portfolio Visualizer

Sector Exposure

Category 25% Stock 50% Stock 70% Stock
Basic Materials 3% 2% 2%
Consumer Cyclical 10% 9% 9%
Financial Services 15% 14% 15%
Real Estate 14% 13% 10%
Consumer Defensive 9% 8% 10%
Healthcare 6% 7% 9%
Utilities 21% 23% 18%
Communication Services 4% 3% 5%
Energy 4% 6% 5%
Industrials 8% 6% 8%
Technology 7% 8% 9%

Source: Created By the Author Based on Portfolio Visualizer

Summary

With higher risk of recession as suggested by slowing growth and the recent inversion of the yield curve, it is prudent to reduce risk in portfolios. These model portfolios are a possible range of options for the investor interested in a higher-yielding portfolio. As I approach retirement within the next few years, I will be doing more tax planning, particularly with respect to withdrawal strategies and the impact of taxes. CD Ladders, the bucket approach, reducing risk, and increasing yields in a prudent manner are primary methods.

Disclosure: I am/we are long VWIAX, VFITX, FPNIX, FSDIX, FSREX, PONAX, SPLV, VTABX. 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: I am an engineer with an MBA nearing retirement and not an economist nor an investment professional. The information provided is for educational purposes and should not be considered as advice. Investors should do their due diligence research and/or use an investment professional.