October 23 2020

Why Yield Matters?

Textbook says that the yield refers to the earnings generated on an investment over a period of time. It includes interests and dividends. The end of the game in finance is to solve for the highest yield for a given risk profile. In a nutshell, you want to put your money at work, without risking losing your shirt.

The thing is that lower interest rates have shifted the yield curve down. You need to assume more risk for the same probability of return. Not really tempting, isn’t it? The question becomes, how far do you push the needle. Well in all things diversification is key, and spicing up your portfolios with private lending, or high yield investments is not a bad thing so long as you don’t become over exposed, and the economy tags along.

Asset managers are seeking to raise $300bn in private credit to quench this thirst for illiquid assets, even though they are sitting on a pile of $272bn un-invested money. In fact, there is no single week where we are not solicited to invest in a collateralized lending product, or a private credit fund. One should welcome the democratization of such investments, certainly when it comes with a yield of 7% to 11%. However, real estate aside, the rule of thumb is probably to cap illiquid assets at 20% of your overall portfolio.

There are actually a couple of places where higher yield is not antithetic with lower risk. Arguably, tech stocks are a high-beta component of the market, and embed a promise of greater reward for a risk that is about 30% higher than the S&P500. This higher risk comes with a yield (0.90% annually) that is half of the S&P500 though (1.83%). Higher yield, lower risk could co-habit.

The same comment could be transposed to crypto assets, which originally didn’t carry any dividends or interests. This is fast changing now with Defi (Decentralized Finance), and processes like Compound, Maker Dao, Celsius and Uniswap. Blockchain-based engineering developed crypto lending, and yield farming mechanism that are meant to stabilize the risk-return of the highly volatile crypto world. In these cases, yield increases return for a similar amount of risk. This is only the beginning.

360 Advisory – Markets