This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

Income Generation Is a Problem – Plus, The Taxman Clips Your Coupon

By:

Head of SPDR Americas Research

  • Income generation in today’s low yield environment remains a challenge – especially on an after-tax basis
  • Investors could consider diversifying sources of risk with emerging market debt (currency risk), senior loans (credit risk), and preferreds (hybrid of equity and rate risk) to seek higher pre-tax yields – and adding municipals to pursue higher after-tax yields.

The amount of global debt trading below a 1% yield now outpaces the entire market capitalization of the S&P 500.1 That’s a problem as one of the primary functions of bonds in a portfolio is to generate income. In fact, with no major developed nation’s sovereign debt currently yielding above 1.4%,the promise of income from bonds has been, to a degree, broken – leaving just bonds’ potential benefit of diversification.

That is not the worst news, though. If we look at yields beyond the macro level and consider the actual income paid out to investors after taxes, the search for income becomes much more challenging.

One for you, nineteen for me

When yields on the Bloomberg Barclays US Aggregate Bond Index (US Agg) were 3.6% back in 2018, the after-tax yield was 2.27%.3 That was above the average rate of inflation4 and more than equities on a pre-tax basis,5 along with 80% lesser volatility.6 However, current yields on the US Agg are 1.2% pre-tax and 0.76% post-tax.7 On a global basis it’s even worse, with the Global Agg yielding 0.91% pre-tax and 0.57%8 post-tax.

Such low levels mean the standard 60/40 portfolio of global stocks and global bonds now yields the lowest amount on record on an assumed after-tax basis, as shown below. At less than 1%, the yield is below the current rate of inflation (1.4%),9 as well as the inflation expectations over the next three, five and 10 years.10 The same calculus holds if you change the bond side to include more than just investment-grade (IG) rated debt,11 also shown below. Swapping in this 95% IG/5% high yield mix for the 40% of the bond allocation, the entire mix also yields less than 1%, a level still well below inflation expectations. Adding in non-IG bonds in this fashion to a 60/40 allocation increases the after-tax yield by just 4 basis points. That’s a problem.

60/40 allocation

Click Here to Read the Full Article

Footnotes

1 The total market capitalization of bonds with a yield below 1% in the Bloomberg Barclays Global Aggregate Bond Index is 44.6 trillion while the market capitalization of the S&P 500 Index is $32.6 trillion based on data from Bloomberg Finance L.P. as of February 5, 2021
Bloomberg Finance L.P. as of February 5, 2021
3 After tax yield is based on the yield-to-worst and applying the highest marginal federal income tax rate of 37%. This may differ for actual investors based on their tax bracket and it is meant to be an illustration of the impact on taxes in a such low rate environment. It does not account for state taxes or net investment income taxes. Actual results may differ.
4 Average rate of inflation from 2000 to 2020 was 2.1% per Bloomberg Finance L.P. data as of February 5, 2021
Current yield on the MSCI ACWI Index is 1.74% per Bloomberg Finance L.P. data as of February 5, 2021
6 FactSet as of January 31, 2021 based on the monthly returns of the Bloomberg Barclays Global Aggregate Bond Index and the MSCI ACWI Index from January 2001 to January 2021
7 Bloomberg Finance L.P. data as of February 4, 2021
8 Bloomberg Finance L.P. data as of February 4, 2021 based on the Bloomberg Barclays Global Aggregate Bond Index
9 CPI as of February 10, 2021 is 1.4% per Bloomberg Finance L.P. data
10 Based on breakeven rates, inflation expectations are 2.4%, 2.3%, and 2.19% for the next three, five, and ten years, respectively per Bloomberg Finance L.P. as of February 5, 2021
11Based on the Bloomberg Barclays Multiverse Index and the MSCI ACWI Index. The Bloomberg Barclays Multiverse Index has a 5% below investment grade allocation per Bloomberg Finance L.P. as of February 5, 2021

Originally Posted on February 17, 2021 – Income Generation Is a Problem – Plus, The Taxman Clips Your Coupon

Disclosures

Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

BLOOMBERG®, a trademark and service mark of Bloomberg Finance L.P. and its affiliates, and BARCLAYS®, a trademark and service mark of Barclays Bank Plc, have each been licensed for use in connection with the listing and trading of the SPDR Bloomberg Barclays ETFs.

ETF expenses will reduce returns. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. In general, ETFs can be expected to move up or down in value with the value of the applicable index. Although ETF shares may be bought and sold on the exchange through any brokerage account, ETF shares are not individually redeemable from the Fund.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.

Investing involves risk including the risk of loss of principal.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from State Street Global Advisors and is being posted with permission from State Street Global Advisors. The views expressed in this material are solely those of the author and/or State Street Global Advisors and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Tax-Related Items (Circular 230 Notice)

The information in this material is provided for informational purposes only and does not constitute tax advice and cannot be used by the recipient or any other taxpayer to avoid penalties under any federal, state, local or other tax statutes or regulations, or to resolve any tax issue.

Disclosure: Forex

There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.

trading top