What Does “Lower-for-Longer” Mean for Equity, Fixed Income Allocations?

A shift in Fed1 policy means the era of ultra-low interest rates is poised to last even longer. While that is likely supportive of equity markets, it begs a question of fixed income allocations: How much should investors allocate toward an asset class where future returns look increasingly diminished?

Fixed income remains an important component of broader investment portfolios due to its diversification benefits. But with interest rates so low, the long-term return potential of less risky segments of the bond market is severely limited.

This point becomes more evident when you examine the current average yield to maturity2 for various segments of the U.S. taxable bond market. The total return3 potential for each segment is severely limited in the future without a continued decline in the general level of interest rates. As you can see from the table below, segments such as high yield may offer better return potential, but carry higher levels of credit risk.

Name of Fixed Income ETF4

ETF Ticker

Average Yield To Maturity as of 9/14/2020

Duration (Years)

iShares U.S. Treasury Bond ETF5




iShares Core U.S. Aggregate Bond ETF6




iShares MBS ETF7




iShares iBoxx $ Investment Grade Corp Bond ETF8




iShares iBoxx $ High Yield Corp Bond ETF9




Source: iShares (www.ishares.com/us)

In light of those return prospects, some investors may be reconsidering their fixed income allocations. For investors who wish to allocate a small portion of their portfolio away from the asset class – without taking on excessive risk – defensive equity strategies may provide a potential solution.

At Reaves, our strategies are defensive by design. We focus on a limited number of industries that provide non-discretionary, essential services that the entire economy depends on. We go a step further by actively managing investments in these sectors to avoid equities with greater risk. This focus, we believe, leads to a portfolio of companies that has a lower risk of earnings declines, even in recessions, and has historically led to better returns than broader equity benchmarks during periods of market stress10. In addition, in a scenario where inflation begins to increase, we believe that the dividend growth of the portfolio would help to offset the downward pressure on price/earnings multiples11. Fixed income securities have historically been weaker than equities in a period of rising inflation and interest rates.

We have mentioned it in a previous blog, but the performance of our Long Term Value Strategy10, through two of the worst bear markets, serves as an example of the defensive qualities our portfolios possess. In the 8½ year period from 9/1/2000 to 2/28/2009, the S&P 500 Index12 had a cumulative loss of -43.5%. Our strategy appreciated 20.2% in the same time frame.

We believe the strategy’s ability to hold up in down markets makes it a viable substitute for investors looking to allocate away from fixed income. Our approach potentially provides more upside than bonds, particularly in today’s low-rate environment and, in holding periods of at least five years, has preserved capital 99.8% of the time13.

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Reaves Asset Management is an investment adviser registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940. Registration does not imply any skill or training. Reaves is a privately held, independently owned “S” corporation organized under the laws of the State of Delaware.

The information provided in this blog does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities and sectors listed. Investors should consider the investment objective, risks, charges and expenses of all investments carefully before investing. Any projections, outlooks or estimates contained herein are forward looking statements based upon specific assumptions and should not be construed as indicative of any actual events that have occurred or may occur.

1The Federal Reserve System is the central bank of the U.S. The Fed, as it is commonly known, regulates the U.S. monetary and financial system.

2Yield to maturity is the internal rate of return of an investment in a bond if the investor holds the bond until maturity, with all payments made as scheduled and reinvested at the same rate.  A bond fund’s Average Yield to Maturity is the weighted average of the fund’s individual bond holding yields based on Net Asset Value.

3Total Return is the actual rate of return of an investment or a pool of investments over a given evaluation period. Total return includes interest, capital gains, dividends and distributions realized over a given period of time.

4The ETFs included in the data table were selected because they represent the actual current yield across several major sub-sectors of the fixed income market.

5The iShares U.S. Treasury Bond ETF (GOVT: ICE U.S. Treasury Core Bond Index) seeks to track the investment results of an index composed of U.S. Treasury bonds.

6The iShares Core U.S. Aggregate Bond ETF (AGG: Bloomberg Barclays U.S. Aggregate Bond Index) seeks to track the investment results of an index composed of the total U.S. investment-grade bond market.

7The iShares MBS ETF (MBB: Bloomberg Barclays U.S. Mortgage Backed Securities Index) seeks to track the investment results of an index composed of investment-grade mortgage-backed pass-through securities issued and/or guaranteed by U.S. government agencies.

8The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD: Markit iBoxx USD Liquid Investment Grade Index) seeks to track the investment results of an index composed of U.S. dollar-denominated, investment grade corporate bonds.

9The iShares iBoxx $ High Yield Corporate Bond ETF (HYG: Markit iBoxx USD Liquid High Yield Index) seeks to track the investment results of an index composed of U.S. dollar-denominated, high yield corporate bonds.

10Reaves performance data is the Reaves LTV ERISA Composite and, unless otherwise noted, all data is net of fees. The Reaves LTV ERISA Composite reflects the dollar-weighted return of all corporate ERISA pension accounts with assets of at least $1,000,000 under management for all periods presented (the minimum was $900,000 during the period 08/31/10-06/22/12). Returns are time-weighted and include the reinvestment of all dividends and other earnings, net of commissions. The returns also reflect the deduction of advisory fees which are described in detail in our Form ADV Part 2A. The LTV ERISA Composite does not reflect all of the Reaves’ assets under management. The LTV ERISA Composite began on 1/1/78 and ended on 12/20/19.

Reaves’ Long Term Value Strategy (Reaves LTV Strategy) seeks a high risk-adjusted total return. The strategy tends to be invested in relatively larger companies with strong balance sheets, good cash flow and a history of dividend growth. Core positions are accumulated in financially strong, high-quality companies and generally have the following characteristics: strong management, above industry-average growth rates, large/mid-market capitalization and low price-earnings multiples.

11The price/earnings multiple compares the earnings per share reported by a company to the market price of its common stock. This multiple is used by investors to judge the relative value of a company’s stock.

12The S&P 500 Index (“S&P 500”) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The typical Reaves portfolio includes a significant percentage of assets that are also found in the S&P 500. However, Reaves’ portfolios are far less diversified, resulting in higher sector concentrations than found in the broad-based S&P 500.

13Reaves LTV Strategy, as it applied to the Reaves ERISA Composite (ended in 12/20/19), has only experienced losses in a single instance over all of the 445 rolling 5-year time periods since inception.

Past performance is no guarantee of future results.
All investments involve risk, including loss of principal.
All data is presented in U.S. dollars.

Important Tax Information: Reaves Asset Management and its employees are not in the business of providing tax or legal advice to taxpayers. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax adviser.

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