Why you should never judge a book by its cover.
For years we have argued that the income we receive from dividends comes with substantial risks. As a matter of fact, we have written several blog posts on this topic. To be clear, we like dividends, but the problem is the term “income”. Think of it this way, we receive a pay cheque for employment, and for so long as we do the work, we receive our salary. Come rain or shine, that income is the basis of our lives, in that we know we can buy food, get a mortgage or go to the cinema.
Now imagine, getting a notice that from now on, you will no longer get these monies and your pension pot is worth a third less. That is what investors in so called “equity income” strategies are now facing. Purveyors of those strategies relied on the fact that equities always go up. That may be the case in the long run, but what about our income needs in the short term? Equities are now down 35% and many companies are actually scrapping their dividends all together. The problem isn’t just the reduction in income and net worth, but the excess fees people paid for the perception that something magical was going on here. Hint, the dividend yield on many index funds is very similar to that of equity income strategies, but at a fraction of the cost.
Then there are the so-called “absolute return” strategies. For as long as I can remember, the classic model whereby, you put some of your money into equities and the other part into bonds had worked like a charm, offering returns that were very difficult to beat. Nothing wrong with that, but again it is the terminology that is the problem. Fact is, far from being the holy grail, the reason these strategies performed as well as they did, was mostly a function of interest rates going down from the high teens in the eighties to zero after the financial crisis of 2009. That meant we had a virtuous cycle of both asset classes going up at the same time.
Clearly, the party was over when bonds yields turned negative and a large portion of the portfolio was no longer performing. Lest we forget, that what has worked in the past is no guarantee that it will continue to work in the future. Correlations change and what goes up together, can also go down together. With everything now down big as a result of this crisis, it has become abundantly clear that there is nothing “absolute” about putting together a portfolio of stocks and bonds. What is the big takeaway from all of this? You don’t need to pay a premium for simple investment strategies, regardless of the fancy jargon.