Investors seeking high yields in their stock allocations have been flocking to the category known as derivative income funds. This breed of products combines equity index exposure with options to generate income, producing higher-than-bond yields. Inthe first half of 2025 alone, 36 new derivative income funds were launched, and more than $30 billion in net flows were directed to the category.
Higher yields don’t always equate to higher returns. Over the past 10 years, the net return to the derivative income fund category was 7.12%, compared to 12.05% for large blend funds.
But some investors prefer their total return to be disproportionately composed of income. These investors should be aware that the income generated by options in derivative income funds is often treated as ordinary income for tax purposes, and that may drive up an investor’s tax bill.
This is apparent in the stark effect on returns that are preserved after taxes. Over the 10-year period ending June 30, 2025, only about 65% of returns survived taxes for the derivative income fund category, compared to 85% for large blend funds.
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US government debt as a percentage of GDP (gross domestic product) reached 121% at the end of 2024. Many investors may have concerns about the impact of this level of debt on the stock market. While government spending associated with debt may provide a stimulatory effect on the economy, the prospect of higher future taxes and long-run impacts on spending and investment introduces many channels through which spending and debt levels might affect expected stock returns. But what investors may not realize is that the historical data show little relation between debt levels and stock returns. There are numerous examples of countries carrying high debt for extended periods while their stock markets posted double-digit annualized returns. One explanation is that stock markets set prices to the point where investors have a positive expected return given current information. Since country debt is a slow-moving variable, it’s sensible that current prices reflect expectations about the effect of government debt. Plus, economic theory does not offer a debt threshold beyond which a country is in economic peril. Dimensional’s Mark Gochnour, Wes Crill, and Jake DeKinder explore the implications of the rising US federal debt and discuss how investors should respond.
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In the first half of 2025, developed markets outside the US returned 19.0%, outperforming the US and emerging markets. But that outcome masks the wide range of returns across individual countries, from Spain’s 43.0% to Denmark at -5.5%. This kind of dispersion isn’t unusual—it’s a defining characteristic of global investing.
On average, the difference in return between the best- and worst-performing country exceeded 43% over the past ten calendar years. It’s no wonder investors may be tempted to chase recent winners or avoid losers. However, there’s little evidence that timing strategies consistently pay off. Country returns can turn quickly. For example, Canada posted the worst returns in 2015, down over 24%, but was the top performer in 2016, up over 24%. An investor who lost patience at the end of 2015 potentially missed out on the subsequent market recovery.
Country volatility is a normal part of global investing. Fortunately, as 2025 illustrates, investors in a globally diversified portfolio can benefit from international diversification without risking getting on the wrong side of country swings.
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An important function of competitive markets is driving prices to equilibrium. This refers to a state where market prices balance the demand from both buyers and sellers. Every trader who thinks the price of a security is high is offset by one who thinks the price is low. So, they agree to transact, voluntarily, at the current price. If there is insufficient interest in buying, the price must fall until a new equilibrium is reached.
If this sounds too abstract, sports betting markets may be a useful parallel. When an undefeated team squares off against a winless team, few expect the latter to emerge victorious. The only way to induce gamblers to bet on the weaker squad is to lower the“price.” This is accomplished by a point spread indicating essentially how much the underdog can lose by and still be considered a winner for betting purposes.
The largest point spread in NFL history came in 2013 when the Denver Broncos played the Jacksonville Jaguars. The gulf in quality between the teams was so great that nobody would bet on the moribund Jaguars until you spotted them 28 free points. Anything short of that and the supply would exceed the demand for the Jaguars.
In case you’re wondering, the Broncos won that 2013 contest by “only” 16 points. So, the winning bet was the Jaguars. An underdog winning against the spread is far from an aberration – historically, they do about half the time. And that’s the key takeaway from market equilibrium. Winning against the market becomes a coin-flip because the quality of assets has already been handicapped in the prices. In other words, knowing a good company from a bad one won’t help you pick better stocks than the market. You’ve got to have more insight into those companies than other investors, and that’s a tall order in competitive markets.
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Against the backdrop of heightened political uncertainty, potential trade wars, and lower consumer sentiment, investors may have concerns about whether the US could tip into a recession. The National Bureau of Economic Research identifies recessions using backward-looking data, so we won’t know we’re in recession until after it’s begun.
Luckily for investors, markets are forward-looking and generally react before we see slower economic growth show up in the macroeconomic data. This also means that expected stock returns are positive, even when the economic outlook is weak. This is borne out in the historical data. One dollar invested at the start of a recession saw positive returns after three years in 12 out of 13 past recessions. The average of the three-year returns after the start of a recession was 43.2%, which is nearly identical to the 41.8% average return of all three-year periods from 1947 to 2024.
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