- High yield bond programs can offer high income and strong total return in a risk-managed framework
- In periods where high yield bonds are unattractive, however, these programs will sit on the sidelines, failing to generate income or returns
- A multi-asset income portfolio has a larger investable universe, making it more rotational in nature
- High yield bond programs and a multi-asset income portfolio may be a great complement to one another
We’re often asked how the Newfound Multi-Asset Income strategy compares to high yield bond programs.
What are High Yield Bond Programs?
First, let’s start with: what are managed high yield bond programs? Traditionally, these are trend-following strategies that invest either in high yield bonds or short-term U.S. Treasuries.
The objective of these strategies is to capture both the high income and the upside growth potential of high yield bonds while sidestepping the material drawdowns that can occur during significant economic dislocations. In other words, they can go to cash in down trending environments.
Some of the more popular programs we’re aware of include (and, in no particular order):
- BTS Tactical Fixed Income
- Ocean Park High Yield Corporate Bond Program (also known as Sierra High Yield Corporate Bond Program)
- Halbert Managed Bond Program
- Marathon High Yield Program
- CMG Managed High Yield Bond Program
Each of these models has their own unique spin. Some include a slightly expanded asset class universe (e.g. high yield bonds, short-term Treasuries and long-term Treasuries). Each has its own way of measuring trends.
But they all share a common thread: they are attractive because they can offer both significant income as well as growth potential without necessarily subjecting the investor the considerable downside potential of high yield.
So how do high yield bond programs compare to Newfound’s Multi-Asset Income strategy?
Newfound’s Multi-Asset Income Strategy
First, as a brief overview: the Newfound Multi-Asset Income portfolio seeks to generate a significant risk-adjusted income stream. It does so by investing in 16 global high income asset classes, including traditional (e.g. dividend stocks, corporate bonds, global Treasuries) and non-traditional (e.g. high yield, bank loans, EM debt, convertible bonds, preferreds, REITs, mortgage REITs).
The portfolio process has two primary steps. First, each asset class is evaluated for its trend strength: positive trending asset classes are retained and negative trending asset classes are removed from the portfolio.
Once negative trending asset classes have been removed, the remaining asset classes receive a pro-rata allocation based on their risk-adjusted yield. Those assets generating more yield per unit volatility are given a higher weight than those generating less.
For example, we expect an asset class like corporate bonds to hold a higher weight than the more volatile MLP asset class when both are in the portfolio.
Asset class exposures are capped at 25%, so when 3 or fewer asset classes are exhibiting positive trends, the portfolio will build a position in short-term US Treasuries. In fact, if no asset classes are exhibiting positive trends, the portfolio will shift entirely to short-term US Treasuries in effort to preserve capital.
Similarities & Differences
|High Yield Bond Programs||Newfound Multi-Asset Income|
|Single Asset||Multi Asset|
|Goes to cash||Goes to cash|
|High income||High income|
|Strong total return||Moderate total return|
So what’s similar between managed high yield bond programs and our Multi-Asset Income portfolio?
They’re both tactical. They can both generate high income. And both can go to cash in effort to avoid significant losses.
But there are some subtle, though significant, differences between these strategies.
Binary vs. Rotational
First, managed high yield bond programs tend to be single asset and binary in nature. If the trend in high yield is off, the portfolio will shift to cash. This can help preserve capital but also means that the portfolio may sit on the sidelines for a long period of time, failing to grow or generate income. There is a potentially large opportunity cost embedded in this model.
In our Multi-Asset Income portfolio, we take a diversified, multi-asset approach. If the trend in high yield is off, we will remove it from the portfolio, but will re-allocate the capital to other positive trending asset classes. This means that if our signal for high yield is “off” for months (like has been since October 2014), we can still generate income and growth by investing elsewhere.
Managing Whipsaw Risk
Second, by being a more concentrated portfolio, we believe high yield bond programs, with their “in or out” modality, are more subject to whipsaw risk. For example, if high yield bonds sell off, a high yield bond program may sell out and move to cash. But if high yield bonds then rebound, the program has not only ridden the exposure down, but it failed to participate in the rally.
With a broader universe of exposures, a multi-asset income portfolio is likely to be more rotational in nature, with shades of grey between “in” and “out.” So while we may also remove exposure to high yield, and fail to capture a subsequent rebound, the capital will likely be reinvested in other asset classes that may be simultaneously rallying.
Better Diversification to Broad Equities
Finally, a multi-asset income portfolio is likely to be less correlated to broad equity returns than a high yield bond program. This comes from exposure to high yield bonds themselves, which have had a monthly correlation north of 80% to the S&P 500 since 5/2007. By comparison, the average correlation of assets in our investment universe to the S&P 500 is 60%.
“Sounds great. Sign me up.”
From my totally one-sided and biased exploration so far, it seems like we should kick high yield bond programs to the curb and invest in multi-asset income strategies instead.
But it would be irresponsible of me to not at least provide the other side of the story.
Because there are certainly times that high yield bond trading programs will shine over multi-asset income portfolios.
For example, high yield bonds have the ability to post astoundingly strong total returns from a combination of high income and price appreciation. A more diversified portfolio that generates the majority of its return from yield – like our multi-asset income portfolio is designed to – will likely have a more muted total return profile.
For example, high yield bonds rallied 28.52% in 2009 – which was even more than the S&P’s 26.35% return. A more diversified portfolio focused on income generation will likely never have a return of that magnitude.
Secondly, high yield bonds are often one of the highest income producing assets. A more broadly diversified multi-asset income portfolio will likely generate less income.
Finally, when evaluating an investor’s portfolio from a holistic perspective, it may be easier to identify how a high yield bond programs fits than a multi-asset income portfolio. This is because a high yield bond program is very constrained in what it can invest in. It would be easy to replace a high yield bond allocation with a high yield bond program.
But a multi-asset income portfolio spans a variety of asset classes, requiring more thought to ensure that the resulting portfolio stays within an investor’s objectives and risk tolerances.
Either or? How about both.
Fortunately, investing doesn’t have to be an “either or” discussion.
We believe high yield bond programs can either be viewed as risk-managed high yield exposures or an opportunistic growth strategy with a strong income bent.
A multi-asset income portfolio, because of its broader diversification, can be used to help diversify a portfolio away from equity beta, while still supplementing income.
In fact, we believe a strong argument can be made to use two such approaches in conjunction with one another. The high yield bond programs will shine in environments like 2009 while a multi-asset income approach can help to generate income in environments where the high yield bond program is in cash.
And since the Newfound Multi-Asset Income portfolio is risk managed, with the ability to shift entirely to cash, both approaches are unified in their belief that capital preservation is a key objective.