With yields on bonds still stuck well below historic averages, multi-asset ETFs designed to boost income from multiple sources such as stocks, bonds, preferred stock and master limited partnerships have emerged as a complement to traditional fixed-income portfolios. Multi-asset ETFs offer yields that typically range from around 4% to 6%—well above the 2% to 3% yields currently being offered by many bonds and dividend-paying stocks. That’s one of the most obvious draws. Another is the group’s one-stop diversification. By casting a wider net for yield, these ETFs claim to offset at least some of the interest rate risk associated with bonds in a rising rate environment.
“As the Fed continues to raise interest rates, advisors are looking to diversify income-producing investments to help weather the storm of rising rates,” says Ryan Issakainen, a senior vice president at multi-asset ETF sponsor First Trust.
“These ETFs are a good way to address that issue because they diversify among several types of income-producing investments.” Many of these funds also automatically rebalance quarterly to avoid straying too far from their target allocations, and that injects discipline into the investment process since the funds are selling assets that have done well and are adding to those assets that have lagged.
According to ETF Database, there are 68 exchange-traded funds that fall into the multi-asset classification. About half of them are growth funds that offer one-stop portfolio diversification and focus mainly on the stock market. The rest, which typically have the words “income” or “yield” in their names and contain investments more appropriate to that theme, fall into the income camp.
Despite their high yields and diversification benefits, however, multi-asset ETFs have some potential pitfalls. Their returns can vary enormously from fund to fund, and many are so new they haven’t experienced a prolonged period of rising rates or sharply falling stock prices. Among those that have been around longer, the five-year annualized returns have ranged from less than .05% for the Arrow Dow Jones Global Yield ETF (GYLD) to 6.67% for the PowerShares CEF Income Composite Portfolio (PCEF). [Note: all figures in this article are as of September 20, 2017]
By comparison, the S&P 500 has returned an average of 13.8% a year over the same time period, while the Barclays U.S. Aggregate Bond Index has returned 2.15%.
There’s also the broader question of whether allocation funds—including these—are a shortcut that is more appropriate for retail investors than financial advisors. “With the exception of very small accounts, where trading costs are going to be an issue, it’s better to cut out the middle man and do portfolio allocation yourself,” says Charles Sizemore, the chief investment officer at Sizemore Capital Management and a portfolio manager at online investment firm Covestor. “As an advisor, you have to ask how you are adding value and justifying your fees, and I don’t think these kinds of funds necessarily do that.”
David Fabian, managing partner at FMD Capital Management, has a similar view. “The benefits to a multi-asset income fund is that you get one-stop exposure to a highly diversified pool of assets with the goal of generating high monthly dividends,” he says. “The downside is that you don’t have the flexibility to under- or overweight certain areas based on your investment risk tolerance or goals. It’s also fairly easy to replicate these types of multi-asset funds with four or five individual ETFs. That way you can size each position to your liking and potentially have more flexibility to change your exposure profile over time.”
Fabian believes that while these funds may be useful for retirees and others seeking to generate an income stream from portfolios, they would likely not resonate with a younger, growth-oriented investor.
The expense ratios here are also fairly high for the ETF world, ranging from 0.60% to more than 2%. Many of these multi-asset products invest through other ETFs, so they have both internal management fees and fees from the outside funds. The most expensive ones invest in pricier closed-end funds.
Sorting Through The Options
Despite these drawbacks, the approach might appeal to those looking for a one-stop route to alternative income sources. The trick for multi-asset ETF shoppers is to sort through a variety of competing and complex strategies and pick one that matches both their risk parameters and investment outlook. Some funds have a hefty allocation to bonds, which could be a plus if the stock market tanks and bonds hold steady. On the other hand, funds with a heavier presence in equities might fare better than their bond-laden brethren in a rising rate environment, in which stocks do well.
According to ETF Database, the largest fund in the multi-asset income category is the $856 million First Trust Multi-Asset Diversified Income Index Fund (MDIV), which has a 0.67% expense ratio and a 5.14% yield. It’s also one of the more diversified funds. Launched in 2012, it follows a market-cap-weighted index consisting of dividend-paying equities, REITs, preferred securities, master limited partnerships and high-yield corporate debt in roughly equal proportion.
Another option with a larger fixed-income focus is the iShares Morningstar Multi-Asset Income ETF (IYLD), which sports assets under management of $338 million, an expense ratio of 0.59% and a 4.58% yield. Structured as an ETF of ETFs, its eight holdings have a roughly 60% bond representation; a 20% allocation to dividend-producing equities; and 20% in REITs, preferred stock and other alternative income sources. Its top bond holdings—the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)—together account for over one-third of the fund’s assets.