Why we focus on ‘total return’ (and what that means for your portfolio)
When evaluating the performance of our strategies from our fixed income desk, we focus on total return. In our view, it’s the clearest way to evaluate whether we’re actually growing (and preserving) your capital over time. It’s also how we build and manage our separately managed accounts (SMAs), from the ground up.
Let’s break down what that actually means.
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Total return has three main components:
- Interest earned — tax-exempt or taxable, depending on the structure
- Capital appreciation or depreciation — how the market values the bonds over time
- Interest on interest — the power of compounding
That last piece is often linked (maybe apocryphally) to Einstein, who supposedly called compound interest the “eighth wonder of the world.” Whether he actually said it or not (and who likes to let facts get in the way of a good story? Not I!), the idea holds: reinvested interest creates exponential growth over time, especially when managed intentionally.
So, how do those three parts play out in practice?
It depends on a few variables: maturity, duration, reinvestment rate, and holding period. Shorter-maturity securities (with lower durations) tend to generate most of their total return from interest income (not because the other components don’t exist, but because there’s less time for price movement or compounding to make a meaningful impact). Absent a credit event, those securities tend to be pretty stable.
Longer-dated bonds, on the other hand, introduce both more price sensitivity (aka more potential for both appreciation and loss) and a longer runway for reinvestment. The longer you hold them, the more time they have to “roll down the curve” and shorten in maturity, which can also contribute positively to return.
But total return isn’t static… it shifts with the market environment.
In a falling rate environment, for example, capital appreciation can meaningfully boost total return (especially in longer-duration portfolios). In rising rate environments (like the one we’ve recently lived through), reinvestment becomes the unsung hero. As bonds mature or coupon payments come in, that cash can be deployed at higher rates. If you're only measuring yield at purchase, you’re missing the full story.
That’s where a lot of investors get tripped up — they chase yield; they fixate on price. They forget that returns are cumulative… and that every component interacts with the others.
We take a different view.
We believe the best way to generate strong, risk-adjusted returns over time is by managing all three components intentionally — structuring portfolios to take advantage of reinvestment opportunities, layering in appropriate interest rate sensitivity, and adapting our ladder as the market evolves.
That’s why we actively ladder our portfolios, adjusting maturity ranges and reinvestment timing based on a broad set of risk measures. The idea isn’t to “outguess” the market… it’s to stay flexible, stay informed, and keep the full return picture in focus.
If you’re trying to preserve capital and grow it, total return is the best lens we know. And it’s the one we use every single day.
IMPORTANT DISCLOSURES
The information contained in this communication has been designed for general informational, illustrative, and educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any security. Moreover, the information provided is not intended to provide any investment advice whatsoever. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, or any non-investment related content, made reference to directly or indirectly in this communication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. No discussion or information contained herein serves as the provision of, or as a substitute for, personalized investment advice. To the extent that a reader has any questions regarding the applicability above to his/her individual situation of any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. City Different Investments is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal, tax, or accounting advice.