Building Better High Yield Portfolios – III

Balancing diversification and yield

June 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Most yield strategies generated lower returns and Sharpe ratios than the S&P 500
  • Furthermore, most of these are highly correlated to the U.S. stock market
  • Optimization can help to select yield strategies that maximize diversification benefits

INTRODUCTION

Imagine you’ve just left your job and are looking to replace your lost income with yield from your investment portfolio. A financial advisor pitches you a compelling idea: a fund that selects the 50 highest dividend-paying U.S. stocks, all screened to be less risky than the average stock. Monthly distributions, just like your old paycheck – what’s not to like?

Enter Global X’s SuperDividend U.S. ETF (DIV), which does exactly that. Yet over the past 12 years, it delivered a disappointing 3.6% compound annual growth rate (CAGR), compared to the S&P 500’s 13.5%. The reality is that many yield-focused strategies struggle to produce attractive absolute or risk-adjusted returns. Investors often end up sacrificing return of capital in pursuit of return on capital.

But even identifying a high-yield strategy with solid fundamentals isn’t enough – it also needs to diversify the broader portfolio. Unfortunately, popular income strategies like high-dividend stocks, covered calls, REITs, and convertibles are all highly correlated with equities, making them less effective for diversification than fixed income alternatives.

In this research article, we’ll evaluate which yield strategies best complement portfolios ranging from fully equity-based to pure fixed income.

YIELD VERSUS TOTAL RETURNS

As we noted in earlier research (read Building Better High Yield Portfolios & Building Better High Yield Portfolios – II), some of the highest-yielding strategies have delivered remarkably poor total returns.

For example, mortgage REITs offered an average yield of 10.6% from 2014 to 2025, yet achieved a meager 2.7% compound annual growth rate (