Portfolio perspectives

Real yields:  Why they matter and what are they telling us?

We have been bringing up the topic of real yields in our meetings with financial advisors and professional allocators across the country.  Why? Because real yields give us a true picture of investment returns—as they show the return above the market pricing of expected inflation. In other words, real yields reflect the actual purchasing power from an investment. Figure 1 displays how real yields have evolved over the last 20 years.  

Currently, the real yield for 5- and 10-year Treasuries are 122 and 126 basis points higher, respectively, than the median over the last 20 years.  Additionally, during the recent era of easy monetary policy (over the last 20 years), the five-year real yield was negative close to 40% of the time.  The more recent big move upwards in real yields was a byproduct of the Fed’s aggressive push to combat unexpected inflation coming out of the pandemic.  Real yields have remained elevated compared with historical precedent, even as economic growth has remained resilient despite higher interest rates. As noted in the Vanguard 2025 economic and market outlook, for the next decade, we don’t anticipate rates falling back to 2010 levels, and we encourage investors to embrace this higher real rate regime.

This is indeed great news for advisors with clients who are prioritizing both return above principal and income solutions with their fixed income investments.  Such goals can be compromised if real yields are negative. For instance, one loses purchase power over time, even if asset returns remain positive.  For those relying on their investments to produce income, they can become vulnerable to low or negative real yields because their return doesn’t stretch as far and increases the risk of outliving their savings. Both archetypes of investors can benefit greatly by this important transformation in the fixed income investing landscape. 

Recommendations for advisors and potential solutions

Embrace the higher interest rate regime and consider solutions that can help maximize this impact for your clients. For those seeking short-term income solutions, ultrashort ETFs like the 0-3 Month Treasury Bill ETF (VBIL), Ultra-Short Treasury ETF (VGUS), and Ultra-Short Bond ETF (VUSB), or the Short-Term Inflation-Protected Securities ETF (VTIP) can be suitable investment considerations. For those prioritizing income, Vanguard’s Multi-Sector Income Bond Fund (VMSAX) or ETF (VGMS) could be an appropriate solution.   

Practice management considerations when using private investments

As the private markets have grown significantly over time, advisors are increasingly asking us about the inclusion of private investments in client portfolios. For advisors going through this process, it is important to understand and evaluate the use of private investments from both the client and advisor practice perspectives.

Client and advisor practice considerations with privates

Private investments can potentially play a significant role in helping clients meet their long-term financial objectives, but they take time and resources to implement well.

For the client, the advisor should address whether there is demand for private investments, if there is a willingness to forgo at least some liquidity, and what the client’s level of sensitivity is toward investment fees.

From the perspective of the advisor’s practice, it’s essential to evaluate their internal capabilities and determine when and if they can successfully offer these strategies. Several key factors should be addressed including capacity, internal competencies, informational access, investment options, and regulations. More specifically, does the advisor believe:

• That private investments can improve investment outcomes?
• That they can identify and get access to top managers, along with the ability to provide operational support?

Inclusion of privates in a portfolio

Private investments can be considered part of the investable universe, expanding the selection of available asset classes beyond an all-public portfolio and offering potential diversification benefits and opportunities to enhance returns to a traditional portfolio.

In aggregate, as we see in Figure 2, private markets have generally produced strong returns relative to their public counterparts. Though, importantly, performance comparisons of public and private investments on a risk-adjusted basis are difficult because of the lack of frequent pricing of private investments. 

Realizing the benefits of private investments requires skill in manager selection and access to top talent. These are especially important in the private universe because, unlike most public markets, private markets lack an investable index-based solution. This, coupled with significantly greater dispersion in returns as shown in Figure 3, means the potential benefits of privates hinges, in large part, on being able to identify and access future outperforming managers. These differences also mean that, while the average returns we see in Figure 2 for public markets are both achievable and implementable, for private markets, this is not the case.

Solutions and next steps

Advisors should understand that gaining access to many of the top private managers can be difficult, so working with a larger firm who has access and due diligence capabilities can improve the odds of success with privates. Additionally, the large dispersion in returns from private investments could be offset by a core model with consistent exposures. Using a systematized investment process built around a core model portfolio offers time savings, since private investments can require significant additional time both in interactions with the clients and from an operational and investment perspective.

Portfolio solutions can help advisors with questions about implementation.