Generating Yield in an Evolving Market Environment
This article is relevant to financial professionals who are considering offering model portfolios to their clients. If you are an individual investor interested in WisdomTree ETF Model Portfolios, please inquire with your financial professional. Not all financial professionals have access to these Model Portfolios.
We have been writing a series of blog articles under the umbrella of “generating yield in a volatile market,” most recently in June, and it is time to revisit the topic.
Let’s start by surveying the current market environment. As we write this, the Fed seems determined to maintain its hawkish rate hike policy in an attempt to drive down inflation—raising the Fed Funds Rate by 75 basis points (bps) (0.75%) in June, July and September, with expectations for further rate hikes in its remaining two meetings this year, and potentially into early 2023 as well.
According to the Atlanta Fed, the market certainly seems to expect additional rate hikes going forward, with Fed Funds perhaps reaching 4.00%–4.50% by year-end, though it is also pricing in potential rate cuts as we move through 2023. For some additional perspective, the June 2023 Fed Funds Futures contract is priced for a nearly 4.50% target as of this writing
At the same time, while inflation remains high, it seemingly has peaked and may be moving downward.
After being negative for more than two years, Treasury real yield rates moved into positive territory across the maturity spectrum sometime in mid-June and seem to be continuing this upward trend.
U.S. Treasury Real Yields (%)
Nominal Treasury rates have also been rising, with the short end rising sharply in the face of the Fed’s tightening program. The yield curve has been inverted (as measured by the 10-Year minus 2-Year yield spread) since early July, resulting in calls of recession by many economists and advisors. Perhaps, but the market is sending “mixed messages” regarding slowing economic activity versus a still-robust labor environment.
Finally, credit spreads have trended upward over the past 12 months, with heightened volatility especially in high-yield spreads, as the market tries to determine if we are in or heading toward recession or not.
For definitions of terms in the table, please visit the glossary.
What Is a Yield-Seeking Investor to Do?
One of the themes in several of our recent blog posts is “there is income back in fixed income.” Let’s compare nominal current yields in the fixed income versus equity markets.
For definitions of terms in the table, please visit the glossary.
It seems, indeed, that there is “income back in fixed income,” although it is also true that, so far this year, bonds have not provided the “hedge” to equity risk they have historically. However, given the generally solid shape of most corporate balance sheets, an “8 handle” on high-yield bonds may deserve some attention.
With flat and/or inverted yield curves, investors are not being compensated for moving out in duration in fixed income. One solution for a “rate-hiking Fed” that also can supplement income is Treasury (UST) floating rate notes, which are reset with the weekly UST 3-Month t-bill auction. This reset enables investors to adjust their yield higher with the Fed as it raises rates, without taking on duration risk. The WisdomTree Floating Rate Treasury Fund (USFR) is a solution that seeks to track the experience within the UST FRN market.
On the credit side of the spectrum, as illustrated above, the U.S. high-yield arena has now arguably moved back into its more traditional role of providing income opportunities within a bond portfolio. However, concerns about where the U.S. economy could be headed can be an important consideration when investing in HY credit. The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) employs a strategy that screens for quality to potentially mitigate default risk while also tilting toward income.
Model Portfolio Ideas
In addition to our product lineup, WisdomTree manages three Model Portfolios we think fit nicely into today’s yield environment, depending on investor objectives: an all-equity Global Dividend model, Multi-Asset Income models of different risk bands and the Siegel-WisdomTree Longevity model, which we manage in collaboration with since-WisdomTree-inception strategic advisor Professor Jeremy Siegel.
All these models focus on generating all or much of the current yield out of the equity allocations versus the fixed income allocations.
Let’s look at the current yield of these portfolios (as of August 31, 2022). “Current Yield/Income” refers to the most recently posted 12-month dividend yield, as indicated here.
For standardized performance and the 30-Day SEC Yield for the underlying fund's please click the respective model: Siegel-WisdomTree Longevity, Global Dividend, Global Multi-Asset Income (Moderate Aggressive). All yield and total return information for these model portfolios and all of the underlying securities within those models can be found in our Model Adoption Center.
Let’s examine some hypothetical “typical” client portfolios.
For investors seeking yield, we believe there are multiple ways to achieve this investment goal without taking on excessive risk, including incorporating quality-screened high-yield and dividend-focused equities within the portfolio. For investors wishing not to take on duration risk while benefiting from the Fed rate hiking regime, our Floating Rate U.S. Treasury product may fit the bill as well.
You can get all the details on our individual strategies and our Model Portfolios on the WisdomTree website.
Important Risks Related to this Article
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Jeremy Siegel serves as Senior Investment Strategy Advisor to WisdomTree Investments, Inc., and its subsidiary, WisdomTree Asset Management, Inc. (“WTAM” or “WisdomTree”). He serves on the Model Portfolio Investment Committee for the Siegel-WisdomTree Model Portfolios of WisdomTree, which develops and rebalances WisdomTree’s Model Portfolios. In serving as an advisor to WisdomTree in such roles, Mr. Siegel is not attempting to meet the objectives of any person, does not express opinions as to the investment merits of any particular securities and is not undertaking to provide and does not provide any individualized or personalized advice attuned or tailored to the concerns of any person.
The Siegel-WisdomTree Longevity Model Portfolio seeks to address increasing longevity by shifting the focus to potential long-term growth through a higher stock allocation versus more traditional “60/40” portfolios.
USFR: There are risks associated with investing, including the possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. The issuance of floating rate notes by the U.S. Treasury is new, and the amount of supply will be limited. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
WFHY: There are risks associated with investing, including the possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile