Reiner (cont'd.): Ultimately, in a period of time where rates are going to be rising—and we all need income, and baby boomers are getting older—we’re going to need to find income from other asset classes beyond bonds.
We look at it as three separate sleeves in our Agg Yield. First, there’s a fixed-income sleeve, where we’re dialing up or down the duration risk or the spread, as well as deciding whether you want to be in investment-grade versus Treasurys, or international versus domestic bonds.
The second sleeve is closed-end funds, which I think is a totally opportunistic asset class that’s underappreciated, because they’re generally regarded as illiquid. They also have leverage associated with a lot of them, so a lot of people just stay away from them. But those traits make it a very inefficient market, and closed-end funds give you a relatively cheap way of accessing that type of leverage, which can appeal to ordinary retail investors.
In a rising-rate environment where you see rates moving higher over a 12-month period or longer, closed-end funds do pretty well because of the spread they get by borrowing at a very low interest—the short rate—and lending at a much higher rate.
Finally, the third sleeve is REITs, MLPs and preferreds all combined into one group.
ETF.com: So the old traditional model of equities plus bonds no longer fits. Investors have to accept that they’re going to have to look elsewhere to find yield?
Reiner: It depends on your expectations. If bonds are in your portfolio simply not go down when the stock market goes down, you’ll probably realize a negative real rate of return. But that may be OK to people if they’re just looking for a risk-off allocation.
However, the problem is that we’re in a world where people need yield, and you’re not going to get that yield out of bonds for a while. You need to seek out other opportunities to increase that yield.
I believe your total overall return will be better if you combine some of these equitylike income securities, like MLPs and preferreds and REITs, and also have a higher yield. In fact, you could have not only a higher current yield, but if you manage it properly, you could end up with a significantly better total return relative to bonds, which, theoretically, will lose some of their value as rates rise.
ETF.com: What kind of yield should investors expect from your Agg Yield portfolio? What’s the target?
Reiner: It’s 5 to 7 percent, but it depends on whether we’re in a risk-off mode or not. We allocate both across each sleeve—fixed income, closed-end funds and REITs, MLPs and preferreds, dialing up or down the allocation in each of the sleeves—and we allocate inside of each sleeve, being strategic about things like duration.
If we go huge risk-off, and we go overweight to fixed income, the yield may be closer to 5 percent, as opposed to right now, where we saw tremendous value in closed-end funds. We’re overweight closed-end funds, so our yield is like 6.6 percent.