A lot of investors simply want to lock in a reasonable level of income to fund their lifestyle needs. That's a real challenge right now.
Even 30-year Treasury yields are barely keeping up with the core CPI and the Fed remains committed to making sure they stay there. Locking in the income the bond market currently provides seems like a precarious long-term proposition.
Those who want to preserve purchasing power would ordinarily pivot to dividend stocks in order to have any chance of beating inflation. Unfortunately, the COVID shock has already eliminated $42 billion in quarterly payments that a lot of people were counting on.
Until we see forward rates come back, confidence will remain brittle at best. We just can't count on paper yields right now, and since reliability is a major draw in this end of the market, it's no wonder the stocks are struggling . . . which compounds the uncertainty shareholders feel.
Of course they can swallow their feelings and chase more speculative stocks in the hope that go-go capital gains will replace steady income. But that's going to be a wild ride and the ultimate outcome is not guaranteed, which is exactly the opposite of what these people crave.
To get the guarantee, they can always sell everything and buy an annuity contract that will pay a reasonable rate of return. Depending on the carrier, that can be an expensive, confusing and ultimately self-defeating choice.
You know all of this already. What's changed is that a relatively recent wave of ETFs now offers something like an annuity's dependable return profile at a fraction of the complexity.
The Global X TargetIncome™ 5 (TFIV), for example, reminds me of a classic old-school hedge fund that invests in assets that theoretically produce reliable income regardless of ambient market conditions.
TFIV targets a 5% absolute annual return. Compared to annuities that guarantee the equivalent of a 1% to 3% yield, that's a tempting prospect.
How well does it live up to that promise? So far, so good. The fund launched in July 2018 and paid the annualized equivalent of 5.3% that year . . . 2 percentage points above prevailing Treasury rates.
In 2019, shareholders who bought in at $25 earned another 5.08%. A little more than halfway through 2020, they've gotten another 2.52% while Treasury rates have hit the floor. Even in the depths of the pandemic shutdown, at least $0.095 a month per TFIV share flowed back to shareholders.
Admittedly, we need to subtract fees from these return numbers. TFIV isn't the cheapest ETF around because like a classic hedge fund of funds it invests in other funds that aren't free, but even at a full-freight 0.77% the income stream is high enough to justify the expense.
We know that risk-averse clients are more than willing to pay that much in exchange for peace of mind, as long as the net returns stay high enough to pay the bills. It isn't what the S&P 500 and its random walk provide in the long term, but it's been reliable so far.
Someone might try to squeeze an extra 30 to 40 basis points of net return by creating a copycat allocation, but that's probably a recipe for second-guessing and angst, which is exactly what we're trying to prevent here.
The portfolio is just sophisticated and dynamic enough to let the people who built it keep running it. They know what they're doing. They hit their targets.
And even in a zero-rate world, they're doing what they set out to do. There's a lot of effort behind the scenes devoted to keeping the portfolio on the efficient frontier. Every time the Fed moves, they need to move with it.
Watch the relationship between TFIV and its cousin TFLT, which aims to capture 10-year Treasury rates plus 2 percentage points. Similar universe of feeder funds arranged slightly differently in order to hit a much easier target.
When the Fed feels confident enough to start backing away from zero-rate policy again, TFLT might become extremely interesting. For now, I'd settle for knowing that I've locked in 5% . . . and I suspect a lot of your clients are in the same boat.