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At CLS, we prefer to look at risk relative to a broadly diversified equity portfolio. We find our investors are typically most comfortable using equity benchmarks to interpret portfolio results. This approach keeps our investors’ interpretations of risk and return consistent. Applying this risk framework to the income space, we have found the typical strategy carries 65%-85% of the risk of a broadly diversified equity portfolio (and about 3x the risk of a typical multi-sector bond fund). This level of risk would be consistent with a moderately aggressive investor. Not necessarily a low-risk approach but still appropriate for an investor with sufficient risk tolerance.

When Income Strategies Do Best; When They Don’t

Unfortunately, no investment approach works all the time, and income strategies are no different. Understanding what environment leads to strong vs. weak results is of critical importance to all investors. 2016 has provided a good example of when income strategies can be expected to exhibit strong relative performance. Through the second quarter, the yield on the 10-year Treasury fell by 80 basis points (bond prices move inversely with yields). This dramatic move has been a major tailwind for income strategies, though other developments, including the recovery in commodity prices, have contributed positively.

The environment that would most likely cause income strategies to underperform would correspond with rapidly rising interest rates. No surprise here; it is the opposite of the scenario that has led to superior results. As yields rise, the prices of bonds fall. In many cases, other asset classes that typically deliver a high level of income also fall. The risky asset now looks less attractive as the risk-free asset becomes more competitive from an income standpoint.


Unlike many funds and strategies available in the marketplace that adhere to an asset-class-specific mandate, income strategies adhere to an investment outcome. This inherently makes them asset allocation portfolios. A strong benefit is a wider set of asset classes available for the manager to take advantage, but that can make selecting an appropriate benchmark more difficult.

An appropriate benchmark should be representative of the manager’s opportunity set. This helps measure and manage active asset allocation decisions. In this circumstance, a blended benchmark is generally the best option. The benchmark should include traditional asset classes, such as global, dividend-oriented stocks and investment-grade bonds. Non-traditional asset classes would also be suitable, including high-yield bonds, preferred stock, master limited partnerships (MLPs), REITs, and emerging market bonds.

SEE MORE: Is Your Bond Portfolio Riskier Than You Think?


Despite the historically low level of interest rates, there is still reason to believe they will not spike in the near term. Nominal economic growth is expected to remain low. The amount of developed international government debt trading at a negative yield is measured in the trillions. Lastly, it is unlikely that we have seen the end of volatility in the equity market.


The demographic shift in the U.S. has created higher demand for strategies focused on the distribution phase rather than the accumulation phase of an investor’s life. Strategies exist today to take advantage of this shift, and they have been performing extremely well. Challenges still exist however, including matching investors’ risk exposures with their tolerances, educating them on the market conditions that lead to outperformance vs. underperformance, and establishing an appropriate benchmark to assess active management decisions.

Rusty Vanneman is the Chief Investment Officer at CLS Investments, a participant in the ETF Strategist Channel.

Disclosure Information: 

This information is prepared for general information only. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice. 2207-CLS-7/28/2016