The article appeared in the February 2021 issue of Morningstar Fund Investor. Download a free copy of Investor Fund through site visit.
Where did the income go? A recession lowered high-quality yields in 2020, and fiscal and monetary support spurred a lower-quality rebound that kept yields fairly low overall. But performance is not everything. As Morningstar Chief Personal Finance Officer Christine Benz and others have pointed out, you can also invest for a total return and sell some of your popular mutual funds and stocks to pay for certain expenses. retirement. Certainly, it makes sense to be flexible rather than striving for yield.
But to see how things are going today, I looked at the 13 top-performing funds in the Morningstar 500 as of January 25, 2021, although the chart shows returns as of March 8. It’s one of those “don’t try this at home” things. I select the M500 list primarily on Morningstar Analyst Ratings, but I also include large and promising funds that may or may not be rated Neutral. It is therefore a fairly safe place for this exercise. If you were to do this for the whole universe of funds or the whole universe of stocks, you would come up with a list of risky investments that could explode you.
SEC yield to 12 month yield
Let’s take a look at the two most common performance measures. The SEC return is a monthly estimate of the 30-day annualized return of the portfolio, subtracted from the expense ratio. The value of SEC yield is that it is timely and forward looking. The 12-month return represents the income actually paid in the last 12 months, including short-term capital gains. Rather than an estimate, this is an actual number. In addition, for equity funds, it can capture dividends better, as they are paid quarterly rather than monthly.
The downside to the 12 month yield is that some of them are in the distant past. If interest rates were significantly different, say nine to twelve months ago, that 12-month return may be significantly different from the portfolio’s current return. In addition, the fund may have increased risk to increase return during this time period, or it may have reduced it. The difference between the 12 month return and the 30 day SEC return can often give you an idea of where the fund’s returns are heading. If the 12-month yield is higher, the yield drops. If it is lower, the yield increases. However, both are not perfect measures from apples to apples, so this is not a perfect indicator.
For this article, I have classified by SEC yield.
High yield bond
Naturally, there are a few high yield bond funds on the list. But I should note that yields are not far from historic lows, so caution is in order. The four high yield bond funds here are led by Hotchkis & Wiley High Yield (HWHAX), which has an SEC yield of 4.2%. The sudden slowdown in February and March 2020 crushed high yield funds; the four here have lost between 21% and 23% in just a few weeks. Energy and other economically sensitive bonds fell in particular. But high yield recovered enough for the remainder of the year to help nearly all high yield funds end with small gains.
Former Pimco managers Mark Hudoff & Ray Kennedy run Hotchkis & Wiley High Yield with a mix of aggression and defensiveness. They lean a little towards higher quality but favor small issuers which are more sensitive to the economy. As a result, they had a strong run until 2018 and are now three years underperforming. This is why the fund’s performance is now so important. So I would say you are certainly taking some risk in buying the fund today, but you are getting seasoned managers and a decent return.
T. Rowe Price High Yield ranked bronze (PRHYX) has a more modest return of 3.8%, but it has been fairly consistent. Rodney Rayburn took over from Mark Vaselkiv at the end of 2019, but he is a seasoned investor backed by a strong team of 17 analysts.
Overall risk is fairly typical for its Morningstar category, but the strategy diversifies into bank loans and high yield foreign bonds. These sectors add yield and diversification.
Fidelity High Income, ranked Bronze (SPHIX) has a yield of 3.5% and is supposed to be Fidelity’s tamer high yield fund, but it has had a tough 2020 due to some energy holdings. Managers Michael Weaver and Alexandre Karam are supported by Fidelity’s analyst team.
BlackRock High Yield Bond (BHYAX) offers a yield of 3.2%. The fund’s A shares get a silver rating and its personal pillar gets a high rating because manager Jimmy Keenan and BlackRock’s in-depth analyst group have been impressive. Keenan adds high quality bank loans and bonds for diversification as the strategy is worth $ 26 billion. What’s really interesting here is that Keenan and his team have outperformed their peers in just about every type of market. The selection of shows and top-down construction made the fund a winner.
Emerging Markets Bond
High risk doesn’t always mean high return. Our three emerging market bond funds have attractive returns, as they often do, but their 10-year returns ranged from 1.3% to 4.9% annualized until the end of 2020. They offer diversification and there is the potential for strong returns. However, macroeconomic events and currency movements often spoil the party.
Fund companies also seem puzzled by these challenges. They struggle to find the right people and the right strategy. Consider the three emerging market bond funds on our list. They represent three of our favorite bond managers in Fidelity, Pimco and T. Rowe Price, but we rate all three funds as Neutral as these companies have struggled in emerging markets. I should note that Pimco Emerging Markets Local Currency and Bond (PELBX) belongs to the category of emerging market local currency bonds, which offers greater currency diversification but has experienced particularly low yields and higher volatility.
With returns between 4.0% and 4.4%, they can increase your income, but they don’t reduce volatility. If you dip a toe, think small.
Yes, we know why this has arisen. Energy stocks collapsed in 2020 as the global economy slammed into pauses in response to the coronavirus. Cutting-edge energy (VGENX) lost 31% in 2020 and has an annualized loss of 3.3% over 10 years. Some energy companies went bankrupt and others cut their dividends to preserve their cash flow. Nevertheless, the fund has a good return of 3.3%.
Yes, energy funds illustrate my point that with return comes risk. In fact, Vanguard turns this fund into a half-energy, half-utility fund. He changed his benchmark to reflect his new outlook. I imagine the fund will continue to have relatively high return and high risk in its new form.
This is one of the most promising areas for yield research. Equity income funds are primarily in the large cap category and generally try to outperform an index. Sometimes they are also required to hold income producing securities exclusively. Well-managed equity funds don’t go after the biggest dividends because companies that are on volatile ground often pay them. Rather, they pursue a more total return approach by seeking attractive stocks and dividends. The best also avoid betting too much on low growth sectors such as utilities.
Vanguard High Dividend Yield Index (VHYAX) has a well-designed index and, of course, low costs. The Silver-rated fund follows the FTSE High Dividend Yield index, which favors diversification rather than maximum return. This has led him to more stable and higher quality stocks than typical income equity funds, and that seems like a smart move. It is also available as an exchange traded fund with the ticker (VYM).
After energy, real estate was one of the worst places in 2020. The value of shopping malls and offices fell dramatically as the world stayed at home to slow the spread of COVID-19. Have REITs fallen enough to offset this sharp drop? I don’t know, but if they did, then it should be a decent place to invest.
Fidelity Real Estate Income (FRIFX) is one of the more profitable entrants in the category, as it invests in a wide range of types of securities in order to increase its income. In addition to REITs, it holds debt securities issued by real estate companies, preferred REITs and commercial mortgage-backed securities. The fund returns 3.3%.
We maintained our medalist ratings for this fund even though Mark Snyderman handed over the reins to Bill Maclay at the end of June. Maclay is experienced and has a good track record in similar strategies.
Most bond funds lose money when interest rates rise, but bank loans adjust to changes in interest rates, so your losses are likely to be little or no loss. This makes bank loan funds good diversifiers for the bond side of your portfolio. However, they carry a credit risk. Losses in the bank loan category during the COVID-19 liquidation were only a hair short of those in the high yield bond category.
Additionally, bank loans carry liquidity risk which presents challenges for mutual fund managers responsible for day-to-day liquidity. Typically, funds hold cash or short-term bonds to handle redemptions. They also have lines of credit, and sometimes bank loan funds exploit them.
Two Silver rated bank loan funds are listed: Fidelity Floating Rate High Income (FFRHX) and variable rate of prices T. Rowe (PRFRX). Funds return around 2.9% and 3.6%, respectively. I like both their careful management of liquidity and their ability to research individual issuers.
Allocation – 30% to 50% of equity
This is a good category to start looking for income. The strategies here typically have broadly diversified portfolios of stocks, high quality bonds, high yield bonds, and perhaps other types of assets. Some of the funds with “income” in their name, however, take a fair amount of risk to increase returns.
BlackRock multi-asset income rated bronze (BAICX) don’t push too far, however. Michael Fredericks takes a diversified approach with holdings in dividend paying stocks, high quality bonds, high yield bonds, bank loans, emerging market debt and even covered buy strategies. The fund performed well under Fredericks, although it lost as much as its typical counterpart in the sell-off. The fund returns 3.5%.