"The Trouble with Tribbles"

I wanted to title this blog post “The Trouble with Income,” but that did not have the nice ring to it of this old Star Trek episode.  That episode dealt with cute little furry alien creatures called Tribbles that everyone loved, but they had a characteristic that was very bad for the crew of the USS Enterprise (check in at the bottom of this post for a summary of that episode)!  This is not unlike income strategies; everyone loves them, but they have some unfortunate side characteristics.

I have written a lot about income strategies in this post-pandemic environment.  I often cited the prospects of dividend cuts, missed lease payments impacting real estate investment trust (REIT) earnings, and general malaise in earnings growth being the cap that limits return potential from traditional income-generating assets.  Also, traditionally high yielding asset class sectors like energy and utilities have been especially hard hit by the pandemic.  However, there are other more basic factors impacting the difficulty facing income strategies.

As seen from the chart below, over the past 12 months that includes the beginning of the pandemic, some popular income-generating assets like the iShares Select Dividend (DVY) equity fund, a broad core bond Barclay’s Aggregate Bond (AGG) fund, and the diversified State Street Income Allocation (INKM) fund all significantly lagged the S&P 500 (IVV, the black line on top) and the moderate risk diversified iShares Core Moderate (AOM) fund.

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Though we can discuss this issue in much more detail beyond the scope of this blog, the major problem of an income strategy is that it is NOT a total return strategy!  When an investor has a need for “income,” that is, regular distributions from an invested base that is NOT a return of principal, the universe of investable securities is smaller and by definition LESS diversified than if the focus is total return; a strategy that opens the universe to all investable assets.

For example, in the case of today’s post-pandemic situation, income strategies have underperformed since they would NOT be invested in “growth-type” equity investments; the class of investment that typically DOES NOT pay much, if anything, in the form of dividends.  Growth stocks, of course rebounded strongly after the initial shock of the pandemic and then continued on to new heights.

Likewise, equity investments in the small and mid-cap space generally do not pay a high yield rate so those sectors (that also rose to new all-time highs) are generally NOT part of an income strategy.  This phenomenon is seen in the international and emerging market equity space, as well.  Compounding the problem, investment in some bond funds struggled with weak price performance due to fears of bond defaults resulting from the pandemic (that has partly reversed recently).

So, the pandemic has hurt the total return of income strategies though today, but there are signs that as we emerge from the impact of the pandemic and the economy starts approaching “normalcy” there will be a “rebound” recovery within that universe of investments.  My blog post of January 3, “2020 Q4, Reversion to Mean” addresses the shifting trends we have started to see.

Notes:

Star Trek Original Series Episode Synopsis - Season 2, Episode 15:

To protect a space station with a vital grain shipment, Kirk must deal with Federation bureaucrats, a Klingon battle cruiser and a peddler who sells furry, purring, hungry little creatures as pets.