“Lower for longer” interest rates are here to stay, reducing both current income and future returns. What’s an investor to do? Lauren and Robert make the case for a multi-asset approach to generating income, and offer several allocation ideas.
“Lower for longer” interest rates are here to stay, reducing both current income and future returns. What’s an investor to do? Lauren and Robert make the case for a multi-asset approach to generating income, and offer several allocation ideas.
INTRO
Intro music plays, fades throughout the intro, and then fades back in before we get to newsroom.
LAUREN GOODWIN: Lower interest rates mean less yield for a portfolio. How can investors generate income then? Here’s what matters.
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LAUREN: Live from our respective coronavirus social distancing outposts, I’m Lauren Goodwin.
ROBERT SERENBETZ: And I’m Robert Serenbetz
LAUREN: and this is Market Matters from New York Life Investments.
ROBERT: In this podcast, we the strategists at New York Life Investments will share insights from the Multi Asset Solutions team: what we think matters as we manage investment solutions.
LAUREN: That includes Mainstays’ diversified portfolio series, including the Income Builder fund, as well as bespoke solutions for our partners.
ROBERT: By sharing perspectives and engaging with you – our listeners – we can all become better investors.
… music fades.
LAUREN: Welcome everybody, it’s the week of February 8, 2021, and today we are going to talk about income.
ROBERT: For millennials like us, it can be difficult to believe but… you used to be able to achieve 4-5% yield – or income – from the fixed income portion of your portfolio just by investing in investment grade bonds.
LAUREN: These days, that’s not really the case. At the end of 2020, a staggering $18.4 trillion in global investment grade bonds were trading with negative yields, and 21.6% of bonds within the Bloomberg Barclays Global Aggregate Bond Index, one of the most widely used global bond benchmarks, were likewise trading with negative yields-to-maturity.
ROBERT: And that’s led investors to question whether the traditional 60/40 portfolio – a diversified portfolio of 60% equity and 40% investment grade bonds – really makes sense for investors to achieve their goals.
LAUREN: By means of shameless plug. Robert always mentions that you can check out our insights online, via LinkedIn or newyorklifeinvestments.com. We just wrote a thought piece on this topic and we’d love for you to check that out if you’re interested.
But getting back to the 60/40 portfolio. Yes, yields are low, and they’re low everywhere – across geographies and asset classes. It’s simply not possible to generate the kind of income today that you could throughout most of history. But that doesn’t mean we should dump the idea of diversification.
ROBERT: Despite its challenges, the logic underpinning a 60/40 portfolio provides important benefits for investors. One is behavioral. A strong, consistent income stream that preserves investors’ purchasing power, while not exposing them to undue risk, provides a potential path for financial stability. Another is portfolio construction. High-grade bonds remain a critical offset to equities in times of turmoil, providing important diversification benefits despite their average lower yields.
Portfolio Pause music.
PORTFOLIO PAUSE
LAUREN: That brings us – rather quickly this time – to our portfolio pause: a section of the podcast where we discuss an investment idea. I think this investment theme is one of the most important ideas facing investors today. It’s a challenge for you and I as we plan for retirement. It’s a challenge for those nearing retirement as they face potentially higher drawdown rates from their portfolios. It’s a challenge for institutional investors, who have to seek yield in other asset classes.
ROBERT: And that brings us to the portfolio idea: how do you generate income in a portfolio when it’s so hard to find?
The most simplistic way to think about increasing yield is by increasing risk in fixed income, whether by moving lower in credit quality or by increasing duration. But higher risk isn’t going to be suitable for all investors. While credit spreads can narrow further from here as the economy improves, they are arguably already tight, reducing upside potential. What’s more, higher risk is still present, despite being poorly rewarded in some cases, as is evident in an elevated rate of defaults. In any case, investors considering this approach have to work with strong investment teams who can engage in very careful credit selection.
LAUREN: For investors who can’t take that additional risk, we do feel strongly that it’s time to consider multi-asset income. Maintain portfolio diversification, but look for ways to build income across different asset classes than just increasing risk in fixed income. Here we have three ideas: (1) building income in equity, (2) rotation into 2021 themes, and (3) a global allocation.
ROBERT: Always three things with LG! Okay, I’ll start with building income in equity. When people hear “income” they usually do think of “fixed income”, but equity can provide an important source of income, too. At the end of 2020, the 12-month dividend yield for the S&P 500 was 1.7%, substantially higher than the 10-year U.S. Treasury’s yield of 0.9%. Investors looking to build income in a low-yield world may thus consider adding yield-focused equity to their investment mix.
LAUREN: There are reasons why this is an exciting idea for 2021 in particular, too. First, these equities tend to do better in the early stages of an economic recovery. Compared to their peers, dividend payers outperformed the broader market by 4% in the last four recoveries from recession. Second is a shift in sentiment toward these equities. Dividend payers outperformed the S&P 500 in November 2020 by the highest extent since April 2009. Sentiment may be improving as the market realizes that the worst of dividend cuts is behind us. Both the timing and sentiment for dividend strategies are further supported by a likely continued rotation in leadership. The diverse sector composition of dividend payers positions these stocks to benefit.
ROBERT: That was good teamwork on that topic.
LAUREN: Haha, thank you!
ROBERT: Our second idea, rotation on 2021 themes, touches on a topic we’ve mentioned frequently on the podcast. With vaccine distribution and government support in play, a strong economic recovery is becoming more likely for 2021. We think two are relevant for income generation: infrastructure and value sectors.
LAUREN: The Biden administration pointed to infrastructure spend as an important policy priority. While ambitions for large packages may be held up in a divided government, some spend on surface infrastructure and upgrades to 5G are likely to be passed in the coming years. This trend could benefit both municipal bonds and infrastructure investments that support those services.
ROBERT: An economic reflation would also make a rotation into value sectors more likely. In recent years, the information technology and consumer discretionary sectors have outperformed as low yields pushed investors into the rapid earnings growth that these equities provide. A period of broad economic growth lifting profits across a range of sectors is likely to reverse this trend, benefiting investors who capture the record divergence in performance.
LAUREN: This shift to value is relevant because dividend-paying stocks, or yield-focused equity, tend to be concentrated in value sectors. As a result, we expect any cyclical rotation to strengthen both the price and dividend performance of these equities— a double benefit.
ROBERT: Good teamwork again, haha! Our final idea, global allocation, also has roots in the economic improvement we expect to see in 2021. LG you want to cover that one?
LAUREN: Value sectors are not the only dividend payers likely to outperform as the economy improves. Similarly, international developed equity tends to pay higher dividends, and to be concentrated in more cyclical, value-oriented sectors. And, as in those value sectors, a global improvement in economic growth should improve conditions for outperformance in these regions.
Global economic growth, coupled with friendlier trade policy, is likely to contribute to a weaker dollar, providing still better results for foreign operators when earnings and share prices are translated back into U.S. dollars. By these metrics, we expect dividend payers in an international allocation to outperform.
ROBERT: One last thing before we close here. We’ve given a lot of ideas about the economic improvement we expect in 2021. With all that improvement, investors may be tempted to move into riskier, more cyclical parts of the market. In general, we agree with that idea. That said, moving too far down in quality or too high in risk may not be appropriate for many investors. Just a couple of weeks ago we were talking about the risk of market volatility related to an inflation scare. Who knows what the risk will be in 2021, but investors should be mindful that volatility is always a part of investing.
LAUREN: That’s a great point about risk. One last thing I’ll add: implementing a multi-asset approach to generating income, and taking the three steps we’ve described: adding yield-focused equity, 2021 themes, and a global allocation to a portfolio, may over- or under-expose the portfolio to certain geographies and currencies relative to peers or benchmarks. Investors can consider approaches that include top-down allocation to help manage that risk.
ROBERT: Hey hey! That’s what we do on the MAS team!
Music fades out.
COMING UP NEXT:
LAUREN: Coming up next. I'm watching the inflation figures.
ROBERT: I'm watching earnings season.
SIGNOFF:
LAUREN: That’s it for today. We’ll be back next week for more Market Matters.
ROBERT: Let us know what matters to you.
LAUREN: If you have a question or topic of interest, reach out to us on social media.
ROBERT: That’s right. You can send us your questions or highlight what matters to you by finding us on LinkedIn.
LAUREN: You can also follow our views on our *new* website at newyorklifeinvestments.com and clicking “insights”.
ROBERT: Until then, I’m Robert Serenbetz.
LAUREN: And I’m Lauren Goodwin. See you next time.
Closing music plays during bylines and disclosures .