2012 Issue 2
Issue Features
- Rethinking Cash Portfolios
- Finding Yield in Volatile, Low-Interest Rate Markets
- Younger Adults Face Financial Headwinds
Column: Voices
Departments
Column: Voices
Focus Should Move Beyond Yield
Investors need to give risk and liquidity the same consideration as yield in the portfolio construction process.
By Shundrawn Thomas
— SHUNDRAWN THOMAS
managing director of exchange-
traded funds group,
Northern Trust
When considered in the whole, the challenges facing institutional investors — the changing regulatory landscape, a persistent low-interest rate and low yield environment and flagging global economies — have led to rethinking and reinventing of the portfolio construction processes.
Driving this re-evaluation, however, is more than the search for yield. Liquidity and relative risk, and their relationships to yield, also are part of the renewed focus on ensuring alignment of investment strategies and goals.
Striking the Proper Balance
How an investor addresses yield, risk and liquidity within their portfolio is determined by each investor's specific objectives and investment parameters.
For example, a pension fund may have a large funding gap and, in turn, the plan sponsor may opt to maximize the portfolio's yield by pursuing investments that are perceived to be riskier or less liquid to enhance income generation. This is a reasonable decision based on this investor's specific situation. On the other hand, a foundation might be focused more on the preservation of capital, in which case the investor may be willing to forgo some incremental yield in exchange for principal safety. Again, this is a prudent decision based on that investor's particular circumstances.
There is no one right answer as to how these factors should be balanced within an investment portfolio. Rather, it's important to understand the trade-off between yield, risk and liquidity and use that knowledge to guide your investment decisions.
A Practical Application
Investors can use this context not only as they construct their overall investment portfolio, but also as they develop strategies for specific segments.
For example, short-term cash portfolios historically have been heavily invested in money market funds. Following the 2008 crisis, however, regulatory and industry reform efforts looked to enhance the safety of money market funds at the expense of yield and, in some cases, liquidity.
As a result, these vehicles may be appropriate for a portion of your cash allocation — such as operational cash used for day-to-day needs — but not for the overall allocation. For those portfolio segments where liquidity and yield have greater relative importance and the investor can tolerate a greater degree of risk to principal, other vehicles such as exchange-traded funds (ETFs) might be a more attractive alternative. Like mutual funds, ETFs offer a range of short-term strategies for investors to consider.
As investors reconfigure their investment portfolios to align more closely with their objectives, it's important they remember the relationships between yield, risk and liquidity. You cannot alter one without affecting the others.
© 2013 Northern Trust Corporation
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