Income investors are often obsessed with the search for yield despite the typical conservative nature of their demographic. The half decade of zero returns in safe assets such as CDs and savings accounts has created a reach for yield that has stretched the boundaries of sound portfolio discipline.
Once considered taboo, asset classes such as junk bonds, MLPs, mortgage REITs, and other high yield investments are now common place in many of the portfolios that I review. The seemingly one-sided demand has helped generate relatively solid returns and uncommonly low volatility over the last several years as well.
Now we are starting to see slow signs of decay in junk bond prices as spreads widen and risk appetites in credit securities pull back. This same pattern has been exacerbated in alternative income funds with overweight positions in non-traditional income fields with juicy yields.
As an example, the First Trust Multi-Asset Diversified Income Index Fund (MDIV) carries 80% of its portfolio in preferred stocks, junk bonds, real estate, and MLPs. The remaining 20% is in traditional dividend paying stocks. This ETF has a current 30-day SEC yield of 6.36%, which any income investor would tell you is phenomenal when 10-Year Treasury bonds are paying just 2.25%.
Yet like most things in life, there is no free lunch in the income world. A reach for yield carries with it higher concomitant risk of capital loss through credit contraction, deleveraging, interest rate cycles, and other exogenous factors.
Before today's bounce, fund's like MDIV were trading near their lows of the year despite the relatively sideways price action of traditional broad-based equity benchmarks. This decoupling of high yield and alternative assets from the major stock market indices should be viewed through a cautionary lens.
I'm not trying to pick on MDIV by any means. A look at other similar funds in this class include the Guggenheim Multi-Asset Income ETF (CVY) and Global X U.S. Super Dividend ETF (DIV). These ETFs contain many of the same fundamental holdings and are showing similar trends of sliding prices.
