ARTICLE: THE "TOTAL RETURN" SHELL GAME

Just what is this "total return" thing that Fixed Income Investment Managers like to talk about, and that Wall Street uses as the performance hoop that all Investment Managers have to jump through? Why is it mostly just smoke and mirrors? Here's the formula: 

·     Total Income + (or -) Change in Market Value - Expenses = Total Return…and this is supposed to be the ultimate test for any investment portfolio, Fixed Income or Equity.

·    Applied to Fixed Income Investment Portfolios, it is useless nonsense designed to confuse and to annoy investors. 

How many of you remember John Q. Retiree? He was that guy with his chest all puffed up last year, bragging about the 12% "Total Return" on his bond portfolio while he secretly wondered why he only had about 3% in actual spending money. This year he's scratching his head wondering how he's ever going to make ends meet with a total return that's quickly approaching zero! Do you think he realizes that his actual spending money may be higher? What's wrong with this thinking? How will the media compare Mutual Fund Managers without it? Wall Street doesn't care because investor's have been brainwashed into thinking that Fixed Income Investing and Equity Investing can be measured with the same ruler. They just can't, and the "total return" ruler itself would be thrown out with a lot of other investment trash if it were more widely understood.  

If you want to use a ruler that applies equally well to both classes of investment security, you have to change just one piece of the formula and give the new concept a name that focuses in on what certainly is The most important thing about Fixed Income investing...the Spending Money! We’ll identify this new way of looking at things as part of “The Working Capital Model” and the new and improved formulae are: 

·     For Fixed Income Securities: Total Cash Income + Net Realized Capital Gains - Expenses = Total Spending Money! 

·     For Equity Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money! 

Yes, they are the same! The difference is what the investor elects to do with the “Spending Money” after it has become available. So if John Q's Investment Pro had taken profits on the bonds held last year, he could have sent out some bigger income payments and/or taken advantage of the rise in interest rates that is happening right now! Better for John Q, sure, but the lowered "Total Return" number could have gotten him fired! What we’ve done is taken those trouble making paper profits and losses out of the equation entirely, because of their irrelevance in an investment portfolio that is diversified properly and comprised only of Investment Grade, Income Producing Securities. 

Most of you know who Bill Gross is. He's the Fixed Income equivalent of Warren Buffet, and he just happens to manage the world's largest "open ended" Bond Mutual Fund. How is he investing his own money these days? Well, according to an article by Jonathan Fuerbringer in the Money and Business Section of January 11, 2004 New York Times, he's removed it from the "Total Return" Mutual Fund he manages and moved it into...CLOSED END Municipal Bond Funds where he can now get around 7.0% tax free! (Interesting don’t you think, I bet he read "The Brainwashing of the American Investor" recently.) He doesn’t mention the taxable variety of Closed End Funds, now yielding a point or two more than the Tax Frees, but they certainly demand a presence in the Fixed Income Allocation of tax-qualified portfolios (IRAs, 401k(s), etc.). 

Similarly, the article explains, Mr. Gross advises against the use of the non Investment Grade Securities (junk bonds, for example) that many Open End Bond Managers are sneaking into their portfolios. But true to form, and forgive the blasphemy if you will, Mr. Gross is as “Total Return” Brainwashed as the rest of the Institutional Community...totally; so he is still giving validity to speculations in commodity futures, foreign currencies, derivatives, and TIPS (Treasury Inflation Protected Securities), which increase in yield with the inflation rate. Safer, yes, but the yields are far too dismal. Inflation is a measure of total buying power, and the only sure way to beat it is with higher income levels, not lower ones. If TIPS rise to 5%, REITS will yield 12%, and Preferred Stocks 9%, etc. No Fixed Income Security is an Island! 

As long as the financial community remains mesmerized with their “total return” statistical shell game, investors will be the losers. 

·    Total Return goes down when yields on individual securities go up, and vice versa. This is a good thing. 

·    “Total Return Analysis” is used to engineer switching decisions between fixed income and equity investment allocations, simply on the basis of statements such as: “ The Total Return on Equities is likely to be greater than that on Fixed Income securities during this period of rising interest rates.” This is not! 

You have to both understand and commit to the premise that the primary purpose of Fixed Income Securities is income production. You have to look at the "Income Received" number on your monthly statement and ignore the others. If you don’t agree with the next three sentences; if they don't make complete sense to you, you need to learn more about Fixed Income Investing...try: sancoservices.com/fixedincomeinvesting.htm for starters.