Yield vs. Liquidity in Income Producing Investments


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Yield vs. Liquidity in Income Producing Investments

  1. 1. Yield vs. Liquidity in Income-Producing InvestmentsDavid WrubelD2 Advisors Inc.February 27. 2013For most of the last ten years there has been a tricky balancing act that financialadvisors and investment managers have tried to constantly and successfully perform:Invest for low yield with market liquidity, or higher yield in more illiquid investments.Others have designated this as "The Liquidity Premium Dilemma." It is a tightrope offof which many have fallen.High net worth investors, pension funds, charitable trusts, endowments, and familyoffices live off of the income generated by their principal, income and principal whichebbs and flows based on overall portfolio performance and market factors. Since themajority of a typical debt portfolio’s income derives from the average yield on incomesecurities it holds, maintaining “performance” in the current anemic interest rateenvironment has been problematic.For example, here are historical performance graphs for a few traditional fixedincome investments:      As  of  2/22/2013,  10-­‐year  treasuries’  average  yield  was  1.97%.         1
  2. 2.      As  of  2/25/2013,  AA  yield  was  2.05%.          As  of  2/07/2013,  Baa  Corporate  Bond  yield  was  4.73%       2
  3. 3.  Dividend  Yield,  2/25/2013:  5.97%      REIT  Exchange  Traded  Funds,  as  of  2/25/2013   Annual Annual Dividend Divide P/ESymbol Name Dividend Dividend Beta Date nd Ratio Rate Yield % Active U.S. Real EstatePSR $1.13 2012-12-21 $0.50 1.90% n/a 0.77 FundFRI S&P REIT Index Fund $0.40 2012-12-21 $0.14 2.16% n/a 0.89 FTSE NAREIT Retail IndexRTL $0.86 2012-12-19 $0.42 2.31% n/a 0.79 FundSCHH U.S. REIT ETF $0.77 2012-12-24 $0.26 2.39% 40.14 0.94WREI Wilshire US REIT ETF $1.04 2012-12-24 $0.30 2.73% 40.91 0.74 FTSE NAREITFNIO Industrial/Office Capped $0.85 2012-12-19 $0.22 2.75% 37.69 1.09 Index Fund Cohen & Steers RealtyICF $2.38 2012-12-19 $0.67 2.90% n/a 0.98 MajorRWR SPDR DJ Wilshire REIT ETF $2.23 2012-12-21 $0.64 2.91% n/a 0.91 FTSE NAREIT ResidentialREZ $1.50 2012-12-19 $0.38 2.93% n/a 0.85 Index Fund FTSE EPRA/NAREIT NorthIFNA $1.49 2012-12-14 $0.42 2.97% n/a 1.20 America Index Fund FTSE NAREIT Real EstateFTY $1.38 2012-12-19 $0.36 3.32% n/a 0.83 50 Index FundVNQ REIT ETF $2.34 2012-12-24 $0.80 3.37% n/a 0.94 Dow Jones U.S. RealIYR $2.40 2012-12-19 $0.79 3.52% n/a 0.90 Estate Index Fund IQ US Real Estate SmallROOF $0.98 2012-12-27 $0.20 3.95% 16.46 1.08 Cap ETF KBW Premium Yield EquityKBWY $1.30 2013-01-15 $0.13 4.22% 22.97 0.91 REIT Portfolio Market Vector MortgageMORT $2.76 2012-12-27 $0.78 9.95% n/a 1.00 REIT Income ETF FTSE NAREIT MortgageREM $1.72 2012-12-19 $0.46 11.52% n/a 0.96 REITs Index FundSource: ETF Database – etfdb.com   3
  4. 4. This is not the place to discuss the advantages and disadvantages of these income investments. Arguably, all have a place in a diversified, reasonably prudent income portfolio, side by side with the entity’s allocation to stock and similar investments. The differentiating factor is that all of the fixed income investments highlighted above are highly liquid. Whether such liquidity is worth the premium paid for it (in the form of lower yield for the risk incurred) is debatable. The primary reason investors “pay” this liquidity premium is for the ability to get out of an investment that appears to be going in the wrong direction. Another reason is the ability to sell and take profits, but that begs the question…”what do I do with the proceeds?” A Risk Adjusted Alternative Not all illiquid investments are created equally. Some have high risk/high return characteristics; some purport to be conservative and safe. We believe a key factor in determining how much illiquidity a portfolio can bear is the length of the investment holding period. For example, real estate represents the classic illiquid investment, yet some real estate investments have holding periods of seven to ten years while others have somewhat shorter holding periods. Another key factor we look at are risk-adjusted returns…how much risk has been squeezed out of an investment while retaining high current returns and potential capital appreciation? For example, in our view certain Net Lease Real Estate Funds provide outstanding risk adjusted returns, comprised of high levels of current income and the potential for capital appreciation. We prefer Funds that focus on investing in properties under long term leases to investment grade corporate tenants, with built-in lease increases and where the corporate tenant pays for all the operating expenses of the property. The long-term leases to an investment grade tenants generate predictable, secure cash flow, the opportunity for superior risk adjusted returns, and limit exposure to market fluctuations.EGM V Net Lease Strategy Overview characteristics: A well-structured Net Lease Fund has the following Invest in net lease assets essential to the operations of investment grade tenants Originate sale-leasebacks at attractive pricing EGM V Structure build-to-suit acquisitions at below market cost Strategy Purchase institutional quality net lease assets at a discount Seek to deliver predictable income and equity-like returns while taking bond-like risk EGM V Assets with short term leases Seeks to Avoid Investments with below investment grade credit   4 Proven track record with some of the best returns in the industry EGM V Strategic Ability to creatively structure transactions and move with speed Advantage
  5. 5. A substantial amount of risk is “squeezed out” of such investments because there isno lease up risk, no construction risk, no operating risk, and virtually no re-leasingrisk because credit rated corporate tenants stand behind the leases of what theyconsider to be mission critical facilities. investment grade sector.Investing in a Net LeaseReal Estate Fund where Moodys S&P Fitchthe tenants are, for Long-term Long-term Long-termexample, Pepsico, FedX, Aaa AAA AAA PrimeATT, and DuPont, is not Aa1 AA+ AA+dissimilar to investing in Aa2 AA AA High gradecorporate bonds of thoseEGM Aa3 AA- AA-companies….except: Target A1 A+ A+The bonds are liquid, the A2 A A Upper medium grade A3 A- A-real estate is not. The Baa1 BBB+ BBB+bonds generate a return Baa2 BBB BBB Lower medium gradeof less than 3½% annually, Baa3 BBB- BBB-the net lease perhaps Ba1 BB+ BB+7½% annually.What combination of risk and reward, liquidity and illiquidity, is good for a giveninvestor? Is a 3% long term bond that provides predictable current return butvariable total return that could be less than 3% (and possibly generate a negative totalreturn) worth the implicit liquidity? Is a Net Lease Real Estate Fund with qualitycredit rated tenants that produces predictable 7%+ cash distributions with realisticpotential for upside at sale, but offers no liquidity for 3 to 6 years, worth the reducedliquidity for some portion of an investors assets? Is the loss of 300+ basis points ofcurrent yield too expensive of a liquidity premium for a portion of your incomeproducing assets?Are you taking too much risk for too little return?We think so.You decide!For more information, contact David Wrubel at davidw@d2advisors.com   5