Interest in our High Yield Dow (HYD) strategy has spiked recently. While we are not surprised, we are somewhat apprehensive as we suspect this enthusiasm might be driven by HYD’s strong hypothetical performance of late (see page 38).

While there are good and bad times to begin investing, these moments are obvious only in retrospect. We make no attempt identify these points, so now is as good a time as any to launch an HYD portfolio. However, “return chasing” often ends in disappointment for investors who lack a long-term perspective. The model’s returns have outpaced those of its benchmark indexes handily over the past month, 12-month and 5-year spans, as well as over longer periods. But its monthly returns are also substantially more volatile than those of the benchmarks, and there have been several multi-year periods when the model’s returns have fallen below those of the benchmarks.

The chart on the following page depicts the hypothetical rolling three-year return premium of the HYD model over the S&P 500 Index1 on a calendar-year basis. We chose this index because it is comprised of U.S. large cap stocks and is commonly cited as a proxy for the performance of the U.S. stock market.

Over the entire period shown, between January 1981 and December 2015, the HYD model portfolio provided a total annualized return of 15.5% versus 11.0% for the S&P 500. But the HYD strategy is not for the faint of heart. This stretch included periods of extreme outperformance (Jan 2000 – Dec 2002, +26.8%) as well as underperformance (Jan 1997 – Dec 1999, -19.0%). The chart shows that during that span there were seven three-year periods (orange bars) when the HYD strategy underperformed the S&P 500.

Investors drawn to the model’s recent performance should take note: in the future the HYD approach will almost certainly generate multiple-year returns that lag those of the overall U.S. stock market, sometimes by a wide margin.

Investors should also consider the HYD approach in light of alternatives such the broadly diversified index mutual funds we recommend. The long term returns of these funds have lagged the HYD model returns, but have been far less volatile. Costs are an important consideration as well. The HYD model requires monthly trading, which can be burdensome to individual investors and costly for accounts of less than $100,000. Investors will smaller accounts often find the fund option to be more suitable.

The HYD strategy was designed to address an explicit need for investment income, a need many investors may not share. The model was developed for pooled income trust accounts, which have a specific mandate to generate investment income, but not capital gains, to beneficiaries. The strategy helped to satisfy the income needs of these trusts, while also providing strong overall returns. Investors who have similar trust accounts or who have an explicit need for investment income might find HYD attractive.

Also in this Issue:

New Fiduciary Rule’s Winners & Losers
What Is Fiduciary Advice?
Investing and Control: Where to Focus
Fixed Income and the Economy
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles