Retirement Weekly: Why retirees may want to look beyond traditional income strategies

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Yield hunters have been left scratching their heads over the last year. Interest rates have dropped to near zero, bond yields have fallen substantially from pre-COVID levels, and a number of traditional dividend paying stocks cut or postponed payments due to the pandemic.

This compounding effect, combined with rising inflation, has created an environment that has seen real yields (nominal interest rate minus inflation) at their lowest level since the 1970s, as measured by the U.S. 10 Year Treasury bond. The current inflationary environment is, to put it mildly, less than ideal for yield-focused investors — especially retirees.

When nearing or entering retirement, individuals typically reorient their investment strategy from one focused on capital appreciation to one that can generate meaningful levels of passive income. Income fuels nearly everything in retirement, from living expenses to food to health insurance — as such, retirees need consistent and predictable cash flows to ensure security.

Most people approach retirement income logically with a number in mind. For example, if you have $2 million in your retirement fund and want to live off $100,000 a year, you’ll need to make 5% a year on your nest egg. However, the rub is that you can only do this if you have a reliable strategy for generating that amount of income. If you were getting a 5% yield via bonds and dividends before the pandemic, chances are you’re getting something lower now, especially if you’re factoring in inflation.

If the conventional income strategies retirees typically rely on are not performing, what can they do about it? Certainly, one answer is not doing more of the same. To achieve and maintain a high level of income in today’s environment, we believe investors need to consider alternative income strategies.

Enter pass-through securities

Pass-through securities may present a unique opportunity to find yield in the current market environment. These are a class of publicly traded securities (i.e., stocks) that are mandated to distribute substantially all of their income to shareholders as a trade-off for corporate tax exemptions.

The four main categories of pass-through securities include real-estate investment trusts, closed-end funds, business development companies and master limited partnerships. Let’s briefly run through each of these to explain what they are.

  • Real-estate investment trusts (REITs) can be tax-efficient vehicles for investing in real estate without having to purchase and manage a property. Typically, REITs can be broken into two categories — ones that own mortgages and ones that own physical properties.

  • Closed-end funds (CEFs) are funds that go to market via an initial public offering (IPO) process and are listed on an exchange. CEFs are granted a certain amount of share capital, as opposed to being able to offer an unlimited number of shares over time.

  • Business development companies (BDCs) are publicly traded organizations that help small to medium-size businesses grow by investing in them, usually through lending. The BDC must invest at least 70% of its assets in either private or public U.S. firms with less than $250 million in market capitalization.

  • Master limited partnerships (MLPs) are hybrid structure funds that combine traditional partnerships and regular corporations. The current MLP ecosystem centers on oil and gas pipelines as well as distribution and refining activities.

A potential benefit of investing in a pass-through security strategy is that it is specifically designed to prioritize income distribution, which can be meaningful income for retirees. Add in the benefit of not being subject to corporation taxes and you have a recipe that appeals to investors. In our view, there are three key components for retirees to consider when looking for yield:

  1. The amount of income generated

  2. The consistency of that income

  3. The tax efficiency of the income.

Pass-through securities are one of the few areas of the market that can satisfy all three of these requirements.

Gaining exposure to pass-through securities

The universe of REITs, CEFs, BDCs and MLPs can be complicated to navigate. Luckily, there are exchange-traded funds (ETFs) with diverse holdings across the pass-through securities universe designed to maximize income return.

For instance, the GraniteShares HIPS U.S. High Income ETF (HIPS) invests in some of the historically highest yielding securities across the income categories previously outlined. Through an ETF, investors can experience the high income potential of pass-through securities while limiting the risk associated with any individual type, in other words, having to decide which securities to own.

Pass-through securities have arguably been hiding in plain sight of retirees for a while. In the yield-starved market environment we find ourselves in today, it might be time to revise your current income strategy and consider an allocation to this historically high yielding sector.

Will Rhind is the founder and CEO of GraniteShares, a New York-based independent exchange-traded fund (ETF) issuer. Before founding GraniteShares, Will served as the CEO of the World Gold Trust Services, overseeing the world’s largest commodities fund. He was also a senior executive at ETF Securities from 2007 to 2013 as well as a former principal at iShares.

Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the GraniteShares ETF HIPS, please call (844) 476-8747 or visit www.graniteshares.com/etfs. Read the prospectus or summary prospectus carefully before investing.

Please read the prospectus before investing. Investing involves risk; Principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer term debt securities. Investments in lower rated and non-rated securities present a greater risk of loss to principal and interest than higher rated securities. Investments in foreign securities involves greater volatility and political, economic, and currency risks and differences in accounting methods. Investments in smaller companies involve additional risks, such as limited liquidity and greater volatility. Master Limited Partnerships (“MLPs”) are subject to certain risks inherent in the structure of MLPs, including complex tax structure risks, limited ability for election or removal of management, limited voting rights, potential dependence on parent companies or sponsors for revenues to satisfy obligations, and potential conflicts of interest between partners, members and affiliates. Investments in asset-backed and mortgage-backed securities include additional risks including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. A Real Estate Investment Trusts (“REIT’s”) share price may decline because of adverse developments affecting the real estate industry. REITs may have limited financial resources, may trade less frequently and in limited volume, and may be more volatile than other securities. The risks of investing in REITs include certain risks associated with the direct ownership of real estate and the real estate industry in general. Business Development Companies (“BDCs”) may carry risks similar to a private equity or venture capital fund. BDCs usually trade at a discount to their NAV because they investing unlisted securities and have limited access to capital markets. Closed-end Funds (CEFs”) may be subject to leverage, liquidity risk, credit risk, and losses may be magnified due to the use of leverage. Leverage may increase the risk of loss and cause fluctuations in the market value of the Fund’s portfolio to have disproportionately large effects or cause the NAV of the Fund generally to decline faster than it would otherwise. Unlike mutual funds, ETFs may trade at a premium or discount to their net asset value. Shares of any ETF are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. An investment in the Fund does not receive the same tax advantages as a direct investment in a Pass-Thru Security. Funds accrue deferred income taxes for future tax liabilities associated with the portion of Pass-Thru Security distributions considered to be a tax-deferred return of capital and for any net operating gains as well as capital appreciation of its investments. This deferred tax liability is reflected in the daily NAV and as a result the Fund’s after-tax performance could differ significantly from the underlying assets even if the pre-tax performance is closely tracked. The potential tax benefits from investing in Pass-Thru Securities depend on them being treated as partnerships for federal income tax purposes. The TFMS HIPS Index is constructed to capture high income securities, typically with pass-through structures, across the following sectors: (i) CEFs, (ii) mortgage REITs, (iii) commercial equity REITs, (iv) residential/diversified REITs, (v) asset management and BDCs, and (vi) energy production and energy transportation & processing companies. Energy-related companies included in the Index are expected to primarily be structured as MLPs. CEFs included in the Index are limited to taxable, debt-based funds and may include CEFs that invest primarily in bank loans, high-yield securities (also known as “junk bonds”), foreign securities (including those in emerging markets), and mortgage- or asset-backed securities. You may not directly invest in an index. Distribution Rate represents a single distribution from the fund and does not represent total return to the fund. The distribution rate is calculated by annualizing the most recent distribution and dividing it by the most recent NAV. 30-Day SEC Yield is a standard yield calculation developed by the Securities and Exchange Commission that allows for fairer comparisons among bond funds. It is based on the most recent month end. This figure reflects the interest earned during the period after deducting the Fund’s expenses for the period. This information is not an offer to sell or a solicitation of an offer to buy shares of any Funds to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. Please consult your tax advisor about the tax consequences of an investment in Fund shares, including the possible application of foreign, state, and local tax laws. You could lose money by investing in the ETFs. There can be no assurance that the investment objective of the Funds will be achieved. None of the Funds should be relied upon as a complete investment program. The investment program of the funds are speculative, entails substantial risks and include asset classes and investment techniques not employed by more traditional mutual funds. Investments in the ETFs are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund is distributed by ALPS Distributors, Inc, which is not affiliated with GraniteShares or any of its affiliates