The Never-Ending Hunt for Yield

Higher-yielding corners of the bond market got slammed over the summer as skittish investors flocked to safe-haven alternatives. But as rates fall on basic fixed-income investments, such as bank deposits and Treasury debt, income investors will continue their quest for extra yield.

Brace for some wide swings in the principal value of your higher-income-paying securities over the rest of 2019, as trading turns more unpredictable. But until and unless the U.S. economy tanks—note that projected growth of roughly 2% with low inflation is a sweet spot for income investors, not a letdown—you’ll get paid in full and on time with most investments.

I therefore see no reason for a massive, defensive response to Federal Reserve rate cuts, volatile oil prices or the explosive Treasury bond rally, which saw 10-year T-bond yields plunge from 2.02% to 1.71% in a single week, sparked by increasing trade tensions with China. There is no need to raise cash and stuff it into three-month CDs or safe deposit boxes because the return on cash is falling. Online banks have already decreased saving rates and will probably take rates lower still. Money market fund yields track the Fed’s rate actions, and the Fed may cut rates further.

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Thriving amid chaos. The current backdrop is good for bonds and dividends. Those who interpret the financial markets’ late-summer disarray as a prompt to trim risk will likely do it by unloading richly priced tech stocks and other shares sensitive to global trade issues and recession, including construction and farm machinery. Oil-related investments will remain uncertain; so will emerging markets. But “credit sectors look more appealing [than stocks], and the reach for yield will continue,” says Yung-Yu Ma, chief strategist for BMO Wealth Management. That bodes well for non-government-backed, yield-focused investments, such as high-grade corporate bonds, commercial mortgage pools, bank-loan and credit card receivables, and the shares of nonbank lenders.

Ma and other big-picture thinkers know that as the yield on long-term Treasuries collapsed last summer, yields on some risky sectors such as junk bonds rose (meaning prices fell)—a traditional indicator of economic uncertainty. I believe, however, that junk and some other, similar assets were already expensive, so an adjustment was overdue. I still like funds such as Northern High-Yield Fixed Income (symbol NHFIX), yielding 6.8%, and RiverPark Strategic Income (RSIVX), yielding 4.6%. They lost less than 2% of their net asset values during investors’ recent, manic flight to the full faith and credit of the U.S. Treasury. NHFIX has a return of 11.9% for the year, and RSIVX, a short-duration high-yield fund, 3.0%. (Prices and returns are through September 6.)

You may be wondering how to recapture the 0.25 percentage point and more in yield that cash and new short-term investments no longer provide. Corporate bonds rated A and BBB are sound choices. Real estate investment trusts and utilities are also fine. Their prospects for growth and higher dividends have less to do with Federal Reserve activity than with the economy, especially jobs, payrolls and consumer spending. One of my favorite high-yield ideas, the consumer-focused conglomerate Compass Diversified Holdings (CODI, $19), is typical. It started 2019 at $13, clambered up to $20 in late July, lost a buck and change during the summer swoon, and started climbing again. It yields a whopping 7.6%.

Warren Pierson, a senior bond manager for Baird Funds, says he would be surprised if interest rates completely reversed their recent fall, so your capital gains (paper profits, if you will) in bonds and bondlike investments won’t disappear. The market can certainly overreact to headlines. But the case for doing nothing or sticking with what’s working is persuasive.