Move Along…Nothing to See Here

There were a couple pieces of advice given in yesterday’s Wall Street Journal that I thought deserved a closer look. First up, Bank of America is recommending dividend stocks as a fixed income substitute because bonds yields are so low:

Bank of America recommends “high-quality” stocks that have growing dividends. These stocks benefit from a low-rate landscape because their regular cash payout ratios are, in some cases, higher than those of bonds or investing in the S&P 500 as a whole.

 They continued:

Even if the Fed increases rates this year as much of Wall Street is calling for, Bank of America says high-yielding stocks will not be severely hurt. “The difference in yield between stocks and bonds is wide enough that bond yields would have to rise significantly before they provide competitive yields to many equities.”

If your only critera for an income-producing investment is the yield you’re going to be in for a big surprise at some point. You can’t just look at the absolute level of the yield when comparing stocks and bonds. They’re two completely different asset classes. A bad day in the stock market is a bad year for intermediate maturity, high quality bonds.

From the peak in late-2007 to the bottom in early-2009, the iShares S&P Dividend ETF (SDY) was down nearly 55%. In that same time the iShares Aggregate Bond ETF (AGG) was up around 8%. On the other  hand, when interest rates rose in 2013, AGG was down about 3% on the year.

Your stock yield is not going to protect you in the event of losses.You always have to think in terms of total return when thinking about income investments, not just the dividend or bond yield.

The second piece of advice comes courtesy of Wells Fargo on long/short hedged equity allocations to a portfolio:

Historically hedged-equity, or long-short, strategies perform best when markets are volatile and in periods when the values of different stocks move less in lock step. “Right now we think we’ve entered into a period of both, which is a perfect environment,” said Adam Taback, head of global alternative investments at Wells Fargo Investment Institute in Charlotte, N.C.

Last year, his research unit recommended hedged-equity strategies only for the most aggressive clients. This year it favors a 3% to 6% hedged-equity strategy allocation across most client profiles.

Earlier this week I said investors should always have a reason for every allocation in their portfolio. This gentleman thinks this is the perfect environment for a hedged-equity strategy. But if you’re going to hedge then hedge. What good does 3-6% of your portfolio do for you in a hedged-equity product?

Well, it can’t hurt, right?. It sounds reasonably intelligent to clients. If something goes wrong, we’ve covered all of our bases. This is really just a smoke screen. If you really want to hedge out some of your equity exposure then just do it. A 3-6% allocation in a portfolio is not a hedge, it’s a copout.

It gives you a false sense of safety and security but really makes no difference from a diversification perspective. Checking every single box when it comes to a wide range of strategies sounds great in theory, but it can get overdone. Diversified portfolios don’t need to hold a little bit of everything. In fact, you could argue that too much diversification is a bad thing at a certain point when you start adding things just for the sake of adding them.

As an investor you should be saying no to way more investment opportunities then you say yes to. Just because something’s available doesn’t mean it’s necessary.

Sources:
Morning Moneybeat: Here’s Where to Find Yield (WSJ)
Some Advisers Turn to Hedged-Equity Strategies in Choppy Markets (WSJ)

Further Reading:
It’s Not a Chase For Yield, It’s a Chase for Fees
Doing Nothing is a Decision

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  1. Mark Massey commented on Feb 13

    Bank of America, 2011 called and wants its investment advice back. Glad I do not depend on BOA for my investment advice.
    As for the hedge fund guy Adam Tabak with the Wells Fargo Investment Institute (what a cool sounding name his employer has!), he would love for every investor to put 3 to 6% of his/her portfolio in a Wells Fargo-sold or managed long/short fund that has a 150 bp or higher mgmt fee. He is not a fiduciary, so what does he care? And what is an “investment institute”? Does WF keep PhD’s housed in a campus-like setting think-tanking away on alternative investment ideas?

    • Ben commented on Feb 13

      I think the fact that stocks are getting expensive and interest rates are so low makes it difficult for these banks to not go out on a limb and suggest that their clients try something, anything, different. They have to try to prove their worth, which often comes at the expense of client returns.

      • Mark Massey commented on Feb 14

        The old, “let’s do something, even if it’s wrong” strategy. Take action when sitting tight works better for the client. Fine by me. Makes it much easier for me to compete.

  2. Financial-Fitness commented on Feb 16

    I agree with you (almost) 100%. One exception to your argument could be the investor who is able to live on dividend income without having to sell shares. If they have the discipline not to sell on the dips (I know, a big if), then a solid dividend stock strategy could be an alternative to bonds. At least, it may give you comfort to push up your equity allocation a few % points (e.g. 65% to 70%). But I fully agree that stocks are not bonds and they should not replace your entire bond allocation.

    • Ben commented on Feb 16

      That is a possibility. The only caveat is that they definitely need to be liquid elsewhere in case their spending breaches whatever the dividend yield in the portfolio is. If spending stays constant then things should work out. If there’s an unexpected expense and they have to sell at the wrong time it could be painful.

      • Financial-Fitness commented on Feb 16

        I read many financial blogs and yours is among the best out there. Thanks and keep up the great writings.

        • Ben commented on Feb 16

          Hey thanks. I appreciate that.