The Importance of Consistent and Stable Returns in Fixed Income Investments
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In the vast landscape of investment options, income funds have carved out a significant niche for themselves. Designed to provide a steady income stream to investors, these funds are often comprised of a variety of income-generating assets such as bonds, dividend-paying stocks, and real estate related investments. They play a crucial role in a well-diversified portfolio, particularly for those investors seeking regular income, or those looking for a more conservative investment strategy.
However, not all income funds are created equal. Many factors affect the amount of income generated, the volatility of returns, and the safety of principal. To assess the stability and consistency of returns these factors must be identified and monitored over time. In the following sections, we delve deeper into the importance of consistent and stable returns of an income fund, and how they can influence an investor's allocation decision-making process.
Understanding Stable Returns
Stable returns refer to the predictability of generating income from an investment over time, which is a key element for income funds. Do they provide a steady flow of returns and assurance of regular income, irrespective of market conditions?
Stable returns don't necessarily mean a fixed return, but rather, returns that have low standard deviation on a month-to-month basis. The advantage of stable returns over fixed returns is that this may allow investors to benefit from favorable market conditions. For example, when interest rates increase, a fund could charge borrowers higher rates, leading to higher payouts for investors. A fixed payout would not benefit from these market events. If interest rates fall, a fund that pays a stable yet slightly variable rate might pay a little less, but if rates fall enough, even the fixed payout funds will have to adjust their payouts as they will be mostly likely be running a negative spread.
“Stable returns refer to the predictability of generating income from an investment over time, which is a key element for income funds. ”
Example:
| Market Scenarios | Fixed Payment | Stable Fund |
|---|---|---|
| Current Market | 10% | 11% |
| Rising Interest Rate (+3%) | 10% | 13% |
| Falling Interest Rate (-3%) | 10%* | 11% |
*Will most likely have to adjust rates as the market is demanding less than 10%. Fund will be running at a negative spread or they will increase risk in the portfolio to make up for short fall.
Achieving stable returns requires a well-thought-out investment strategy, a diversified portfolio, diligent risk management, and operating in an inefficient market space. Additionally, funds offering a fixed percentage return might incentivize more risk-taking to achieve higher returns for the manager, potentially exposing investors to unexpected risks. Therefore, understanding the attribution of returns is crucial for effective financial planning and risk management.
The Importance of Consistency in Returns
Consistency in returns is a critical factor in the success of income funds. When we refer to consistency, we're talking about the ability of an income fund to generate a steady stream of positive returns over time.
Consistent returns play a significant role in building investor confidence. Investing inherently involves a degree of uncertainty and risk. However, an income fund that has a track record of delivering consistent returns can provide investors with reassurance that the fund is managed effectively and is capable of weathering different market conditions. It is important to understand what cycles the fund has gone through. Many funds established since 2009 have claimed success in supplying consistent returns. That should be expected, as for over a decade, those funds had not seen any negative gap events that created a prolonged economic impact. How have they done in adverse cycles?
“When we refer to consistency, we’re talking about the ability of an income fund to generate a steady stream of positive returns over time. ”
Furthermore, consistency in returns is often indicative of a well-diversified portfolio. A diversified portfolio spreads investments across a variety of assets, reducing the risk that poor performance in one investment will significantly impact overall returns. This diversification can contribute to more consistent returns, further enhancing the attractiveness of the income fund.
However, it's important to remember that past performance is not always indicative of future results. While an income fund may have a history of consistent returns, investors should continue to consider the fund's investment strategy, the experience and expertise of the fund manager, and the fund's approach to risk management on an on-going basis.
Kirkland Income Fund: A Case Study
The Kirkland Income Fund is a principal preservation-focused high-yield income fund. Unlike traditional income funds that invest in bonds and dividend-paying stocks, the Kirkland Income Fund is a private debt fund, originating micro-balance commercial real estate loans used for the rehabilitation of middle-income affordable housing and neighborhoods.
The Kirkland Income Fund has generated consistent positive returns since its first loan in April 2020, despite the COVID pandemic, changes in the market landscape, historical levels of Federal open market operations, bank failures, and geopolitical unrest over the past couple of years. Here is the monthly return for the fund since its inception for reference.
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 0.89% | 0.88% | 0.83% | 0.87% | 1.02% | 0.85% | 0.88% | 0.85% | 0.84% | 0.99% | 0.89% | 0.96% |
| 2022 | 0.89% | 0.91% | 0.75% | 0.90% | 0.95% | 1.00% | 1.01% | 0.90% | 0.84% | 0.88% | 0.95% | 1.00% |
| 2021 | 0.82% | 0.73% | 0.68% | 0.68% | 0.74% | 0.74% | 0.69% | 0.87% | 0.92% | 0.94% | 0.95% | 0.88% |
| 2020 | 0.44% | 0.61% | 0.62% | 0.54% | 0.73% | 0.69% | 0.79% | 0.85% | 0.71% |
The Kirkland Income Fund has also demonstrated stable performance over the years with low return fluctuations month to month. Since April 2020 (fund inception), the fund’s annualized return has been 10.19% with an annualized standard deviation of 0.45%.
The annualized standard deviation of the fund shows very little variation in returns. In contrast, the Aggregate Bond Index returns have fluctuated month on month during the same period with negative returns in some months.
Aggregate Bond Index
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 3.08% | -2.59% | 2.54% | 0.61% | -1.20% | -0.19% | -0.07% | -2.11% | -2.41% | -1.58% | 4.45% | 3.51% |
| 2022 | -2.15% | -1.12% | -2.78% | -3.79% | 0.64% | -1.57% | 2.44% | -2.83% | -4.32% | -1.30% | 3.68% | -0.45% |
| 2021 | -0.72% | -1.44% | -1.25% | 0.79% | 0.33% | 0.70% | 1.12% | -0.19% | -0.87% | -0.03% | 0.30% | -0.26% |
| 2020 | 1.78% | 0.47% | 0.63% | 1.49% | -0.81% | -0.05% | -0.45% | 0.98% | 0.14% |
Since April 2020 the Aggregate Bond Index has an annualized return of -1.98% with an annualized standard deviation 6.66%. During the same period, the MSTR Levered Loans Index has returned 9.23% with an annualized standard deviation of 4.52%.
Conclusion
Income funds serve a significant role in an investment portfolio, especially for investors seeking a steady income stream or a more conservative investment strategy. The stability and consistency of returns greatly influences the attractiveness of an income fund, contributing to its overall risk profile.
The Kirkland Income Fund serves as an excellent example of a fund that has demonstrated both stability and consistency in returns*, despite challenging market conditions.
Is it time you consider adding alternative fixed income products to your fixed income allocation?
If you have any questions on this article or the Kirkland Income Fund, please don’t hesitate to reach out.
*Note: Past performance is not indicative of future results
