Income Investments Outperforming Broad Equities as Rates Rise

05/05/22 | Stacey Morris, CFA

With both bonds and equities off to a dismal start to the year and a growing chorus discussing the potential for a recession, income investors may be taking a closer look at their portfolio positioning as they digest recent performance amid rising interest rates. Year-to-date returns from typical income investments have been admittedly mixed, from outright strength in energy infrastructure to resilience in utilities to all-around weakness in closed-end funds. That said, income investments have generally outperformed the -12.9% decline in the S&P 500 (SPX) on a total-return basis through April. Admittedly, some of the outperformance from income investments can be attributed to avoidance of weaker sectors like tech and communication services. This note discusses year-to-date performance for income investments as interest rates have increased.


Energy infrastructure stands out for YTD strength.
An improving macro energy environment driven by higher oil and natural gas prices has supported energy infrastructure performance this year, with broad midstream up 21.3% and MLPs up 18.7% on a total-return basis through April. Energy infrastructure tends to do well in periods of high inflation given inherent real asset exposure and long-term contracts that typically include annual inflation adjustments. Consistent with performance so far this year, rising interest rates are not expected to be a headwind for energy infrastructure companies. An emphasis on debt reduction in recent years should help mitigate the impact of rising rates on borrowing costs, and the more generous yields from midstream/MLPs would suggest some insulation from increased competition from bonds as rates increase (read more). As shown below, MLPs were yielding nearly 7.5% at the end of April, while broader midstream was yielding 5.6%.

Equal-weighted, yield-focused index and utilities prove resilient.
Some of the relative strength in income investments compared to the SPX results from less exposure to sectors that have been particularly weak this year, namely technology, consumer discretionary, and communication services. As shown in the table, combined these sectors accounted for 47.5% of the SPX at the end of April, and each sector is down around 20% YTD. The benefit of having less exposure to these sectors is evident in the performance of the S-Network Sector Dividends Dogs Index (SDOGX), which is the underlying index for the ALPS Sector Dividend Dogs ETF (SDOG). SDOGX selects the five highest-yielding stocks in each sector of the S&P 500 (real estate excluded) and applies an equal weighting scheme. Compared to the SPX, SDOGX has been underweight the three lagging sectors highlighted below and overweight energy, which has resulted in positive index performance through April.


Utilities have also held up well YTD through April, with a slightly positive total return. Utilities tend to be sensitive to rising interest rates given the capital-intensive nature of the business and extensive use of debt. However, utilities are also defensive investments with stable revenues and decent yield. Investors have likely shifted more money into utilities amid broader market volatility.

Closed-end funds lag as interest rates rise.
Closed-end funds (CEFs) can be particularly sensitive to rising interest rates and have seen weak performance in 2022. Many closed-end funds focus on fixed income, and rising interest rates have a negative impact on the net asset value of those funds as bond prices fall when rates rise. CEFs that use leverage can see additional pressure as leverage magnifies returns and as borrowing costs also rise. Rising interest rates also contribute to weakened sentiment for CEFs. Municipal bond CEFs have been particularly weak, falling by almost 20% on a total-return basis year-to-date.

REITs, bonds, and quality dividends are down YTD but still outperforming broad equities.
Rounding out the discussion, other income investments are down YTD but still outperforming the SPX. REITs tend to do well in inflationary periods as they enjoy pricing power and lease agreements with inflation adjustments, but the space has still seen some pressure this year with the rise in borrowing costs. Dividend strategies focused on quality tend to be more defensive and have less exposure to technology, which has supported performance. With interest rates rising, bonds have not surprisingly fallen, but the benchmark bond indexes shown have still fared better than the broader market.

Bottom Line:
On the heels of a challenging April for markets and the Federal Reserve policy meeting this week, income investors may find some consolation in income vehicles having largely outperformed the broader equity market year-to-date as interest rates have increased.

Asset 24@300x-100

Current Yields vs. History

Even with a strong start to the year, midstream/MLPs continue to offer attractive yields, although current yields are below historical averages.


SDOGX stands out from the other dividend dog indexes for its positive performance YTD. The current yield for SDOGX is below its historical average but IDOGX and EDOGX are yielding above their five-year average.


Multiple screens for dividend durability, including evaluating cash flows, EBITDA, and debt-to-equity ratios, help ensure reliable income from the durable dividend indexes.


Closed-end funds have been pressured by the rising interest rate environment, and the current yield for CEFX is above its historical averages.


Related research:

Midstream/MLPs Resilient in Periods of Rising Rates

SDOGX Fetches Higher Yields and YTD Outperformance

Income Opportunities: MLPs, CEFs, and Return of Capital

Income Opportunities: Examining Price and Total Return in 2021

Income Opportunities: Finding Income in an Inflationary Environment

Download PDF