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In 2021, putting together a fixed income portfolio that yielded 6% might have been an impossible task. Unless you felt like diving exclusively into CCC-rated junk bonds, there was almost nothing that was going to get you even near 6%. Even long-term high yield bonds were struggling to eclipse the 5% level. If you were considering investment-grade anything, forget about it! Short-term Treasuries? Next to 0% yield. Even long-term corporates would only get you about halfway to the 6% mark. You’re best bet was probably covered call ETFs, such as the Global X S&P 500 Covered Call ETF (XYLD), but then you’re getting into equities, not fixed income. It was a bad time for income seekers.

Flash forward to today and the environment is entirely different. Yes, yields have come down from their peak during this past spring, but 6% portfolio yields are no longer out of reach. The Fed has already cut by 75 basis points, which has brought the whole yield curve lower, but there are still a lot of opportunities in the fixed income space that allow for the capture of an above average yield without pushing the risk profile.

I started tracking my 6% Target Yield Portfolio a few months ago. Compared to my 5% Target Yield Portfolio, which was mostly achieved just through a combination of government and corporate floating rate notes, this portfolio requires the inclusion of some riskier securities. It started with the core of the the iShares Treasury Floating Rate Bond ETF (TFLO) and the iShares Floating Rate Bond ETF (FLOT), but added three more ETFs around it.

The foundation of TFLO & FLOT provided an ultra-low risk core, which is attractive when generating portfolio income, but the roughly 5.5% yield when balancing the two holdings, wasn’t going to cut it.

This biggest addition to this core was the Janus Henderson AAA CLO ETF (JAAA). This was a logical next step up the risk ladder that rewards shareholders with roughly a 100 basis point yield premium above that of TFLO without adding significant risk. Collateralized loan obligations (CLOs) can be riskier as a whole since they tend to include a lot of lower-rated and more speculative loans. JAAA, however, focuses on the highest AAA-rated tranche of this group, which mitigates a lot of the credit risk inherent in this space. Since CLOs are floating rate, it also reduces much of the interest rate sensitivity as well. For a portfolio where you’re looking to maximize yield and minimize risk, this is a good fit.

The iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) is clearly used to enhance the yield of the portfolio. I’ve long preferred short-term junk bonds for high yield exposure not just because the yield is currently higher, but because of the risk/return tradeoff. SHYG is roughly 20% less volatile than it’s longer-term counterpart HYG and that makes it better for portfolio building.

The American Century Multisector Floating Income ETF (FUSI) is a smaller, under-the-radar ETF. I’m choosing to include it here because it’s an actively-managed portfolio that consists a number of asset classes, including CLOs, MBS, ABS and government securities. These asset classes in the way they’re constructed also eliminates most interest rate sensitivity and also focuses on just the highest rating tiers. There’s some overlap with JAAA, but I like a sector rotation strategy that manages risk in the process.

Note: I recently updated my rankings for the ultra-short term bond ETF category if you’re looking for other higher yield, low risk income options. It can be found HERE.

Because FUSI is a newer fund, there’s not a long track record for this portfolio when it’s included, but there’s enough to get a sense of what we’re working with.

The standard deviation and drawdown figures are artificially low due to the short lookback period. If you remove FUSI and reallocate among the other holdings, the 6% Target Yield Portfolio in its previous iteration is about twice as volatile as the ultra-low risk 5% Target Yield Portfolio, which is to say there still isn’t a lot of risk here.

The max drawdown was about 2% and occurred during the 2022 bond bear market when the Fed was aggressively raising rates. While I wouldn’t eliminate the possibility that rates move higher from here as inflation risk becomes a larger threat, another fixed income bear market like the one we saw a couple years ago seems unlikely. Given the 6% overall yield, a negative total return would be difficult to experience over a lengthier holding period.

In order to adjust to today’s new lower rate environment on the short end of the curve, the portfolio needs to be adjusted in a way that increases the allocations to potentially riskier holdings. It means taking on more risk to capture that target yield, but it doesn’t result in a major change to the portfolio’s risk profile.

The yields of TFLO and FLOT have shrunk by around 40-60 basis points. FUSI’s yield has declined by about 30-40 basis points, but the yields of SHYG and JAAA haven’t moved a whole lot. For the sake of diversification, I’ve decided to pull in a couple more ETFs in addition to the original quintet in this most recent update.

That brings us to the updated allocation for the portfolio.

The 55% combined allocation to TFLO & FLOT gets reduced to 35%. I like the fact that it balances out some of the additional risk that comes from increasing the allocations to lower-rated notes, but the yield is no longer an attractive trade-off. If yields on the short end continue to decline, as I’d expect they would if the Fed is going to keep cutting rates, these allocations may soon shrink to almost nothing. We’re going to need to keep taking on more risk to hang on to that 6% portfolio yield.

I’ve added the Invesco Senior Loan ETF (BKLN) to this portfolio. Given that the volatility level and yield is comparable to that of SHYG, you might be wondering why it’s included. In short, it’s got a moderately different risk profile that could provide some advantages. Senior loans tend to be floating rate, so they usually don’t have the interest rate sensitivity that junk bonds do. They’re also higher in the capital stack than junk bonds, which means they have a better chance of getting paid back in the event of a default by the issuer (although I don’t view that as a high risk right now). The two are still probably going to be highly correlated, but there are advantages to owning both.

The iShares Preferred & Income Securities ETF (PFF) is another example of this. It gets us closer to that 6% yield target with a modestly different risk/return profile as well.

As expected, the added risk in the portfolio enhances historical returns, but also raises volatility.

In the adjusted portfolio to remove FUSI as we did above, volatility is about 50% higher than the previous version, but still not huge in the grand scheme of things. TFLO, FLOT and JAAA have very little volatility to speak of at all and even the other holdings have risk levels much lower than that of AGG. Overall, consider this a short-term bond fund level of risk.

Final Thoughts

The Fed continuing to cut rates will likely affect the yields of TFLO and FLOT relatively quickly, although the others may prove more durable. I suspect I’m going to need to adjust this again at some point over the next several months to account for lower rates on the shorter end of the curve. I’m keeping this specific portfolio as fixed income only, but may create another “growth & income” version of it that allows the inclusion of covered call ETFs and things like that to generate yield.

However, this is still a relatively low risk, diversified portfolio to that allows you to capture that 6% yield without too much extra risk. This may be the best time to go after a yield like this before it likely needs to tilt into more lower-rated and longer duration assets to maintain the yield target.

If you’re looking for a comparison, the 6% Target Yield Portfolio is nearly twice as volatile as the 5% Target Yield Portfolio, although they’re both still relatively conservative.