Reaching for Higher Returns in Our Low-Yield World
In his 6/19/21 Wall Street Journal column entitled “There’s No Magic Answer in Our Low-Yield World,” Jason Zweig once again states some truths that are difficult for many investors to hear. In today’s very low interest rate environment where a 10-year Treasury note yields a little over 1.5% combined with historically high stock market valuations, achieving returns that resemble long-term historical averages will be a daunting challenge for both institutional investors like pension plans and ordinary individual investors. An example of the former is the Pennsylvania school pension fund (PSERS) that has reached for higher returns in alternative investments like hedge funds. Ranking 94th in returns among 133 peers over the last ten years, it has not worked out well for them.
So how should investors approach this difficult situation? Well, according to John Skjervem, chief executive of Alan Biller & Associates and the former chief investment officer of the Oregon State Treasury where he oversaw the management of roughly $100 billion, there are three choices:
Choice #1: “You can raise your existing holdings of traditional risky assets like stocks, even though no one thinks they’re cheap.” Some investors (especially retirees) who seek income have favored high-dividend-paying stocks. Over the last ten years, these stocks (based on the Vanguard High Dividend Yield Index Fund Admiral, VHYAX) have gotten nearly the identical return of a value index fund (based on the Vanguard Value Index Fund Admiral, VVIAX). Unfortunately, this return (about 12.4% annualized) substantially lags the return of a simple total market index (about 14.9% annualized based on the Vanguard Total Stock Market Index Admiral, VTSAX). Another traditional risky asset is high yield (junk) bonds. The Vanguard High-Yield Corporate Admiral fund (VWEAX) currently yields just under 4%, not a great return for the additional risk undertaken as seen in the nearly 20% drop in March 2020. As for preferred stocks, they suffered an even more substantial drop of about 33% (based on the iShares Preferred & Income Securities ETF, PFF).
Choice #2: “You can add a bunch of new and exotic bets and hope they don’t blow up on you.” Although Skjervem may have been thinking of hedge funds, the word “bets” suggests crossing the line from investment to speculation. The newer forms of speculation include cryptocurrencies and meme stocks, both of which incorporate a heavy use of leverage by their investors, further increasing their risk of a severe drop. An article by Anne Tergesen in the 6/26/21 Wall Street Journal perfectly captures this choice with the title and byline, “Saving for Retirement? Now You Can Bet on Bitcoin—Everyday investors are inviting the volatile world of cryptocurrencies into their IRA nest eggs as they search for higher returns.” We wish them all the luck in the world.
Choice #3: “Or you can grit your teeth and stay the course, through a period of what may be lackluster returns, until interest rates finally normalize.” We consider this to be sage advice and would add to it our own counsel of saving more (or spending less) to compensate for lower returns. How long will it take for normalization of interest rates and expected returns to occur? We wish we knew, and anyone who tells you they know is either delusional or a liar.
Skjervem’s final point bears repeating: “People are looking for the silver bullet, the magic wand, the get-out-of-jail-free card. There isn’t one.” We could not agree more.