Chart in Focus: Income investing is not just about “chasing yield”

When focusing on income, and especially when seeking to generate even more of it, investors should be mindful of the implicit biases, risks and trade-offs that could arise. In this discussion, we focus on income vs capital return.

Total return is a combination of capital return (the growth of the capital invested) and income return (the interest received on that capital). Looking across asset classes, the relationship between capital return and income return generally changes as the level of income changes. In short, generating higher income in multi-asset portfolios tends to come at the expense of capital return. This does not mean that total return decreases, but rather that the mix of capital and income returns changes. We examined these dynamics for a variety of asset classes since 1995. As shown in the chart, more income doesn’t necessarily mean higher total return.

Figure 1

To understand why this trade-off exists, consider the example of high-yield credit. Investors can potentially increase expected income in their portfolios by adding exposure to higher-yielding bonds, but doing so will increase credit risk. This means they are more likely to experience defaults that lead to a negative capital return. High-yield bonds may also have limited capital return potential as they typically trade below or near their par value, given they typically have short maturities, and many are callable.

For investors seeking income in multi-asset portfolios, it may be prudent to strike a balance between income return and capital return, which can each be important for different reasons. Focusing too heavily on high-income-producing assets may not only limit capital appreciation potential, but may also restrict the opportunity set.

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