Flipping the Script on Yield

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.

“There is income back in fixed income.”

We first began writing this periodic series of blog articles on “generating yield in an evolving market” back in March 2021 and, most recently, this past March. It’s time to check back in.

When we began this series, we were encountering the anomalous situation of equity dividend yields being higher than bond yields. It was a bleak time for bond investors—rates were near zero, and credit spreads were trading near historical lows.

My, how the “script has flipped,” both at the short end…

S&P 500 Dividend Yield – 3-Month T-Bill Yield

For definitions of terms in the graph above, please visit the glossary.

…and the long end:

Credit More Attractive than Equities

Let’s survey the current market environment. All eyes are on the Fed—it opted to “hold” in its June FOMC meeting, neither raising nor lowering rates, but the bets are leaning toward a rate hike for its July meeting. In fact, the money and bond markets have appeared to come around to the notion that rates will be higher for longer.

What we do know is that the Fed has now shifted into full “data-dependent” mode and will, more than likely, act accordingly. We also hold an experienced belief that the bond market, ultimately, will tell us the answer. We believe the result, for now, is continued bond market volatility.

For definitions of terms in the graph above, please visit the glossary.

At the same time, and despite the Fed’s ongoing anxiety, inflation seems to have peaked and is moving downward, though it remains well above the Fed’s 2% “target rate.”

Treasury real yield rates have been solidly in positive territory across the maturity spectrum since June 2022, and we see no reason why they should reverse themselves and head back toward zero again. In fact, we believe they will grind higher from here, barring a deeper economic recession than we anticipate.

U.S. Treasury Yields (%)

Nominal Treasury rates have also moved higher, with the short end rising sharply in the face of the Fed’s rate hikes. The yield curve has been inverted for months (as measured by the 10-Year minus 2-Year yield and the 10-Year minus 3-Month spreads), resulting in calls of recession by many economists and advisors. Perhaps—we believe even probably—but the market continues to send “mixed messages” regarding slowing economic activity versus a still-robust labor and consumer spending environment.

Finally, credit spreads have widened from their 2021 lows, but they are well within historical levels.

So, What Is a Yield-Seeking Investor to Do?

One of our primary investment themes for 2023 is “There is income back in fixed income.” Let’s compare current nominal yields in the fixed income versus equity markets.

For definitions of terms in the table, please visit the glossary.

Certainly, in comparison to the equity markets, there is income back in fixed income.

Bankruptcies are increasing, but the overall balance sheet strength of most of corporate America remains intact. Given this, potentially generating 8+% on high-yield bonds may seem interesting for advisors seeking yield.

Product/Strategy Ideas

The inverted Treasury (UST) yield curve does not offer much of an incentive to move out in duration. While investors may wish to consider a barbell approach given the current yield backdrop, we continue to see value in tilting the allocation toward Treasury floating rate notes (FRNs).

As of this writing, UST FRNs are the highest-yielding Treasury security, and with only a one-week duration, they offer income without the volatility that potentially comes with fixed coupon issues. The WisdomTree Floating Rate Treasury Fund (USFR) is a way for investors to tap into this investment theme.

Another area to focus on for income needs is the U.S. high yield (HY) sector. Along with spreads widening over the last two years, HY levels have more than doubled over this period to levels not seen in a non-COVID-19-related environment since 2016. However, with a recession of some sort still widely expected, fears of increasing defaults have risen for HY.

An approach to consider that is selective and takes default prospects into consideration. The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) offers investors a way of screening for quality (we exclude negative cash flow companies in our Index construction) while tilting for income in the HY space.

Model Portfolio Ideas

In addition to our product lineup, WisdomTree also 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 our Senior Economist, Professor Jeremy Siegel.

All these models focus on seeking all or much of the current yield out of the equity allocations while using the fixed income allocation to pursue additional risk-managed yield.

Let’s look at the current yield of these portfolios (as of April 30, 2023). “Current Yield/Income” refers to the most recent 12-month dividend yield.

For the most recent standardized performance, month-end performance, and the 30-Day SEC Yield for the underlying funds, please click the respective Model Portfolio: 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.

Now let’s examine some hypothetical “typical” client portfolios.

Conclusions

For investors seeking yield, we believe there are multiple ways to pursue this goal without taking on excessive risk, including quality-screened high-yield (WFHY) and dividend-focused equities within the portfolio. For investors wishing not to take on duration risk while potentially benefiting from the Fed rate hiking regime, our floating rate U.S. Treasury product (USFR) may fit the bill.

Additionally, our yield-focused Model Portfolios are all delivering on their mandates of generating enhanced yield in a risk-controlled manner.

The world always continues to rotate, and for now, we have rotated back into a fixed income, yield-generating state of affairs. Investors and advisors should take advantage of it while it lasts.