Searching for Extra Yield, While Minding the Risk Minefield

The Financial World According to Inya” Column
by Inya Ivkovic, MA

Without a doubt, what individual and institutional investors alike are looking for right now is yield — the more, the better. Even product engineers have tuned in, and businesses are right behind in the conga line. But is it really a party if you have to meander singing and dancing through a minefield fraught with who knows what kinds of risk still lurking out there?

The appetite for yield is understandable, however. Low-risk securities are currently yielding just about nothing and investors are tired of all that post-recession stuff. Of course, who needs a three-percent yielding GIC when there are bonds and preferred shares yielding five to six percent? It seems that there is a great shift towards riskier asset classes, even if such assets are bonds, because they still carry credit risk, and not to mention preferreds, income trusts and REITs, all of which are income-paying securities, bringing into the equation equity risk if the underlying cannot make the payments or declines in price.

Certainly, one way to deal with more risk in one’s portfolio is to diversify it properly. That way, any chance of a credit default or a stock market decline can be alleviated without significantly impacting the long-term returns. Regardless, the risky portion of any portfolio, diversified or not, still brings in more volatility.

Advertisement

Now, if an investor is in the accumulation phase, volatility is often perceived as an opportunity, rather than solely a product of risk. In layman’s terms, if stocks are falling, investors in this phase are likely buying. However, if an investor is actually living off of his or her portfolio, volatility is quite a different kind of beast. If an investor makes a withdrawal when the market is declining, he or she is eating into its invested capital, which decreases its asset base that’s needed to generate future income.

But why is that? That is because risk is not always so obvious and it kind of creeps around portfolios, constantly searching for a point of entry. When the times are good, when prices are rising and when income is flowing, no one sees the risk. The risk comes into the picture only when things turn for the worse. Only when strategies are no longer working do investors start worrying about risk and regretting decisions made earlier.

So, for those on a yield find-and-rescue mission, there are things to consider first. Going forward, fixed income securities are going to be offering lower returns. For those in the accumulation phase, it could mean switching a larger part of your portfolio to riskier securities. For those in the income-generation phase, taking more risk could be an option, depending on how big is your asset base. What would make more sense, however, is learning how to stretch income dollars further and live on less.

Next, the run in the credit market is not likely to repeat any time soon. So, if you are looking for value corporate bonds, don’t spend too much time on the job, they are harder and harder to find. If there is any extra yield to be squeezed out of corporate bonds, look for those that have wider spreads than, say, government bonds, because that is the only thing that would justify the added risk.

Finally, searching for more yield does not mean avoiding other strategies, such as those that generate more income over those that focus on capital appreciation. There are ways to do both. Investors don’t have to rush after high-coupon-paying bonds of poor value. An alternative would be short-term products in combination with high- quality stocks. There are also high-interest bank accounts, although for those you need higher liquidity, as well as plenty of moderate- yielding stocks that are still undervalued and underpriced.

I’d estimate that we need at least two more years of effective cash- parking time, but it’s good to know that it doesn’t have to be only in high-yield securities. Income-geared securities differ little from other types of assets. In the end, the price has to make sense within your individual risk framework and regardless of how badly you may need the extra income.