Cast A Wider Net For Income
Michael Fredericks | July 25, 2013 | Topics: Investing for Income
Point of View With Michael Fredericks
- Investors starved for income need to look outside of traditional income sources.
- Employing a tactical asset allocation strategy can expand opportunities while helping manage volatility.
- Investors should consider incorporating an actively managed portfolio seeking a diversified mix of alternative income sources.
Investors are starved for income with interest rates still near historic lows and volatility punishing portfolios. In this context, Michael Fredericks, portfolio manager of BlackRock's Multi-Asset Income Fund, offers ideas about sourcing additional income and smoothing volatility.
- A wider set of income opportunities exists beyond traditional fixed income sectors, and can provide higher yields and diversification.
- A go-anywhere tactical asset allocation strategy can take advantage of volatile markets to expand income and return opportunities and manage portfolio volatility.
- A manager's ability to take a global best-ideas perspective to managing income, returns and overall risk is critical in this challenging environment.
Can investors improve their income in today's volatile markets?
This could be the biggest challenge for investors today. Yields have come down across asset classes, but remain volatile with wide ranges, as can be seen in the chart at right. For example, the high yield sector has had a yield above 10% and below 5% over the past three years. In addition, many asset class yields are at their lowest point for the past several years, highlighting the income challenge. Conventional wisdom says that in order to achieve higher income and return potential, investors need to stretch into higher risk sectors and asset classes. With markets volatile, moving into riskier asset classes is about the last thing any income investor wants to do. As such, we recommend investors and retirees reassess their income strategy to consider a wider range of income sources through a flexible approach.
We believe taking a go-anywhere approach is critical to allowing an experienced manager to choose the best opportunities to balance income and risk.
How should investors and retirees rethink their income strategy?
The traditional benchmarked 60%/40% equity/fixed income portfolio we believe offers too little income and too much risk. To rethink your portfolio, we suggest going outside of traditional stock and bond sources of income to less correlated alternative sources of income. This approach requires deep resources and expertise to successfully uncover the wide range of potentially complex investment opportunities across the full array of asset classes. As such, we recommend investors rely on a manager with the scale, market knowledge and global insight to manage reallocations.
What are alternative sources of income?
Our approach is built upon the belief that actively managing a diversified mix of alternative income sources with traditional sources such as bonds and dividend equities (see below) can offer attractive risk-adjusted income. Alternative sources of income include non-traditional asset classes such as Master Limited Partnerships (MLPs), preferred stock, real estate investment trusts (REITs), and emerging market debt.
These asset classes can help generate an attractive yield in low rate environment (see definitions below). But these are asset classes that require specific knowledge, so relying on a firm that has expertise across the range of alternative income asset classes and strategies is important.
Master Limited Partnership (MLPs) — These are enterprises that trade on an exchange with a tax-advantaged status, usually deriving income from the extraction and transport of natural resources. MLPs typically pay quarterly distributions.
Emerging Market (EM) Debt — This category represents the bonds issued by less developed countries (such as China, Mexico, Bulgaria, Turkey and Russia), and tends to have a lower credit rating than other sovereign debt based on increased economic and political risks. In turn, the yields have a tendency to be higher.
Real Estate Investment Trusts (REITs) — These tax-advantaged entities primarily invest in real estate, deriving most of their income from rental payments, gains from property sales, and other related sources.
Preferred Stock — "Preferreds" are securities that share characteristics of both stocks and bonds, paying a dividend but not granting voting rights to the holder. They are subordinate to bonds but senior to common stock in their claim to assets of the company.
Bank Loans — These loans typically finance leveraged companies, and offer an interest rate that "floats," or gets reset, on a regular basis based on a benchmark such as LIBOR. This floating-rate feature makes the loans relatively insensitive to movements in interest rates.
Special Situation Debt — Credit-related investments that may become available as a result of asset sales, institutional risk reduction or regulatory reasons.
Does the potential for rising interest rates factor into your income strategy?
Absolutely. This is a major concern for many investors in today's market, particularly income investors. For the better part of the last few decades, fixed income investors have enjoyed positive returns and yields as a result of the declining interest rate environment. With the recent interest rate volatility and the potential for rates to move higher in the future, the landscape for generating income has changed dramatically. Today, income investing requires significantly greater flexibility, particularly when looking at the bond side of a portfolio. The issue is that many income strategies out in the market simply do not have the necessary flexibility to manage a portfolio effectively in this new environment. We believe investors should look for a manager who has the ability to mitigate interest rate risk. In our income strategy, we have the ability to implement a variety of strategies designed to defend against rising rates and are always looking at the full market environment to determine the most effective approach.
What income sources do you favor?
Overall, even with the recent spike in interest rates, the opportunity set is a bit smaller as investors continue to show tremendous demand for certain asset classes, driving yields down, and prices up. Combine that dynamic with volatile markets and we are positioning portfolios more conservatively today. However, we believe equity valuations are attractive and look to selectively add to equity exposure. We also think that preferred stock currently provides attractive income and diversifying sector exposures. Finally, we still favor the high yield bond sector for its attractive yields and low default rates, even though pricing is expensive on a historic basis.
On the other hand, we recently reduced our allocation to emerging markets equity and debt. Until recently, these asset classes offered diversification and income benefits. As of late, this has been outweighed by heightened volatility and underperformance due to disappointing growth expectations in China and continued economic uncertainty throughout emerging markets.
How should investors gain access to all of these income sources?
To construct portfolios incorporating the range of income sources we discussed while not exceeding target levels of risk, it is important to have a dynamic strategy. We believe employing tactical asset allocation (TAA) with a go-anywhere mandate is the best approach. This strategy allows the manager to seek the best income opportunities globally while also managing volatility to provide a complete and balanced approach. While asset allocation strategies do not assure profit or protect against loss, TAA can adapt to challenges while seizing opportunities and we believe offers a better way to improve an investor's income stream, while also reducing the volatility of the portfolio.
We believe taking a go-anywhere approach is critical to allowing an experienced manager to choose the best opportunities to balance income and risk. The flexibility of a go-anywhere tactical approach means that benchmark allocations are not weighing down the portfolio with low yield, high volatility asset classes.
How do you manage a portfolio through tactical asset allocation?
Broadly, TAA takes a different approach from a traditional strategic long-term target portfolio comprised of major asset classes such as stocks, bonds and cash and based on an investor's objective, time horizon and risk tolerance. TAA is an active management strategy in which the manager continuously rebalances portfolio asset class allocations in order to take advantage of risk, return and income opportunities. The chart below shows the dynamic nature of portfolio allocations within the shifting market environment.
A major advantage of TAA is that a manager is able to take a more diversified approach to portfolio management in an effort to control the overall risk of the portfolio and target more consistent results. Using a risk-controlled process, the TAA manager is able to actively rebalance portfolios to find relative value, gain exposure to more attractive asset classes, reduce volatility and potentially increase returns. In this respect, professional managers have enhanced access to information, research and analysis that can help them anticipate economic cycles and better allocate multi-asset class portfolios.
What is your perspective on portfolio volatility?
We feel very strongly that a "one-stop-shop" income solution should closely manage volatility, to cut down on the roller coaster ride and provide the investor with a smoother, longer volatility experience (see chart above). Our strategy of diversifying an income-oriented portfolio by incorporating alternative asset classes with behavior counter to or independent of traditional stocks and bonds helps reduce some volatility.
But we also employ our sophisticated risk management capabilities through proprietary risk tools to track and manage the volatility of a wide range of asset classes and portfolio allocations over time. As volatility increases and remains elevated, we will tactically reduce exposure to riskier assets and add more to positions that demonstrate lower risk profiles. Similarly, as volatility stabilizes at low levels, we will allocate more to higher risk assets.
What risk management do you employ?
Risk management has long been embedded in BlackRock's culture. Our risk management processes include daily risk reviews and stress tests, weekly portfolio construction discussions and monthly senior management reviews of performance and risk levels. Through this comprehensive approach, investment decisions in all our client portfolios are made with an eye toward understanding how each decision might impact the portfolio's overall risk profile.
How should an investor incorporate this income strategy in a portfolio?
In this low yield environment, risk-averse income investors in search of a one-stop-shop should consider a professionallymanaged, flexible income strategy to help enhance the durability, longevity and overall success, of their entire portfolio. We believe a flexible, risk-aware tactical asset allocation strategy that incorporates alternative income sources can potentially increase income and diversification while decreasing volatility of the entire portfolio.
In addition, for investors who may have too high an allocation to cash or core, total-return-style fixed income strategies, this flexible income approach could be a worthy complement to an overall portfolio.
The strategy is intended to be incorporated by replacing some of the higher-risk equity allocation, and a similarlysized portion of low yielding fixed income (see pie charts below). Any portfolio reallocation should take place within the context of an investor's goals, risk tolerance and time horizon, and these considerations should be discussed with an experienced financial professional.
About the Author
Managing Director, Head of US Retail Asset Allocation for BMACS Group
Related by Topic: Investing for Income
Jeffrey Rosenberg, BlackRock's Chief Investment Strategist for Fixed Income, discusses the Fed's approach to tapering bond purchases, how future policy will rely on promises and reviews "My Favorite Themes" and fixed income performance for 2013.
Volatility in the municipal market, while down from the summer months, was evident in November. As the year draws toward a close, BlackRock muni experts remind investors of the importance of proper perspective and offer several reasons for optimism.
Chart of the Week
Most investors fear rising interest rates. Which begs the question – are there alternatives to bonds that might offer income and behave better in a rising rate environment?
For investors looking to invest outside of the U.S., Russ Koesterich offers three attractive areas to focus on.
48%: Portion of American investors that name cash as their dominant asset class
It's easy to lose your composure when markets misbehave. But staying grounded today can reap rewards down the road. Read our seven tips for managing through manic markets.
Stock markets have been on a tear, but it's not too late to participate. BlackRock investment pros offer insight on the opportunity in equities.
The data indicates U.S. investors are under-allocated to international stocks by as much as 50%. Are you missing out on a world of opportunity?
You've anticipated retirement for years. When the saving is done and it's time to take income, how will you know if you're ready? Meet CoRI.
Stuart Reeve & Andrew Wheatley-Hubbard
Three concerns weigh heavily on investors' minds today: slow growth, high volatility and low (but unsettled) interest rates. The BlackRock Global Dividend Team discusses how high-quality, dividend-growing stocks may help.
BlackRock's best recommendations for the current investing environment.
Mark Howard-Johnson & Sherry Rexroad
Mark Howard-Johnson and Sherry Rexroad recommend REITs for potential returns and dividend income, as well as a dose of diversification.
Rick Rieder & Bob Miller
BlackRock's CIO for Fundamental Fixed Income Rick Rieder & Portfolio Manager Bob Miller discuss why investors should consider shifting out of traditional core bond funds in favor of an approach that is adaptable to the rapidly changing bond market.
Peter Hayes & James Schwartz
The municipal market has been the subject of many headlines since Detroit's history-making bankruptcy filing. BlackRock's Peter Hayes and James Schwartz discuss why the popular perceptions are often misconceptions.
Sergio Trigo-Paz & Ernesto Bettoni
Sergio Trigo-Paz and Ernesto Bettoni, BlackRock’s emerging market debt experts, discuss why emerging market debt is so attractive and explain how they construct EMD portfolios.
Peter Hayes & James Schwartz
Detroit filed for Chapter 9 bankruptcy protection July 18, making history as the largest-ever municipal bankruptcy. Peter Hayes and James Schwartz discuss the event and the implications for the broader municipal market.
Peter Hayes & James Schwartz
The economic and fiscal distress in Detroit came as no surprise, but the emergency manager's recent proposal to address it did. Peter Hayes and James Schwartz discuss the plan and its potential implications, while offering recommendations for investors.
Recent volatility in the municipal market, although painful, has also been healthy in that it has restored value in the marketplace. Peter Hayes offers perspective and recommendations for investors.
Times change, and like most of us, you probably update your fashion, technology and maybe even your diet and musical interests to keep pace. Can you say the same about your financial strategies? See if you're up-to-date or behind the financial times.
Earlier this year, portfolio managers of the BlackRock Global Allocation Fund sat down in a live webinar to interact with investors. Missed it? Get the recap.
When it comes to investing, the fastest sprint doesn't necessarily make you a winner. Portfolio managers of the BlackRock Equity Dividend Fund discuss why they believe slow and steady wins the investing race - particularly during volatile times.
Putting a significant portion of your portfolio into cash may seem like a good idea when times are uncertain and volatile. But there is a cost: Holding cash is a sure way to lose buying power in the long run.
Learn about a new approach to portfolio construction and how "alternative" investments can play a larger role for individual investors.
After a solid four-year run, many investors are asking whether it’s time to lock in profits in high yield and move on. Jim Keenan, head of Leveraged Finance at BlackRock, explains why high yield stills deserve a central place in investor portfolios.
Investors in municipal bonds have kept a close watch on how state and local governments have fared in the Great Recession and era of austerity. This report takes a comprehensive look at the current state of states and locals.
Seeking to enhance yield in your portfolio without appreciably increasing risk? BlackRock's Leland Hart says floating rate bank loans may be the answer.
Munis have long been a source of high-quality, low-volatility income. That's true to this day, but BlackRock's Peter Hayes explains why 2013 will not be exactly like 2012...or 2011.
Peter Hayes & Jack Erbeck
After capturing its fair share of news flow in 2012, California enters the second quarter of its fiscal year headline-free and with a notable budget win after voters approved a meaningful tax measure on Election Day.
The votes have been cast; now the hard work begins. In a new report, BlackRock discusses the key challenges and other market implications of the US elections.
Peter Hayes & Jeff Rosenberg
In our pre-election analysis, BlackRock offers suggestions as to where investors can find value in the current markets.
Peter Hayes & James Schwartz
The municipal bond market is rich in opportunity. Learn how careful credit research can make all the difference in the success or failure of a municipal bond portfolio today.
Brian Weinstein & Martin Hegarty
Higher rates of inflation may be on the horizon, and investors should be prepared. BlackRock's senior inflation-linked fixed income experts discuss the value that Treasury Inflation Protected Securities (TIPS) can provide to a portfolio.
* Total returns as of 6/30/13 for BlackRock Multi-Asset Income Fund Investor A shares with maximum sales charge: 1 Year, 10.45%; 5 Year, 6.67%. Since Inception, 5.90% (annualized since fund inception 4/7/08). Total returns with sales charge reflect the deduction of current maximum initial sales charge of 5.25% for Investor A shares. Category average returns for the Morningstar Intermediate Term Category are: 1 year performance, 0.91%; 5 year, 5.60%. Category average returns for the Morningstar World Stock Category are: 1 year performance, 18.01%; 5 year, 3.25%. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Volatility represented by standard deviation, which measures the volatility of the fund's returns. Higher deviation represents high volatility.
Data represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than that shown. Refer to www.blackrock.com for current month-end performance. Total/net annual operating expenses as stated in this fund's most recent prospectus: Investor A shares are 1.30%/0.80%. The fund's net operating expenses exclude acquired fund fees, investment interest expenses, if any, and certain other fund expenses. BlackRock has contractually agreed to waive or reimburse certain fees and expenses until 11/30/13. Contractual waivers terminable upon 90 days' notice.
Investment involves risks. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed income investing are interest-rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Investments in non-investment-grade debt securities (high yield or " junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments in emerging/developing markets or smaller capital markets. Incorporating alternative investments into a portfolio may involve substantial risk and presents the opportunity for significant losses including in some cases, losses which exceed the principal amount invested. Also, some alternative investments have experienced periods of extreme volatility and in general, are not suitable for all investors.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are those of the portfolio manager profiled as of July 2013, and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that may, in certain respects, not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
You should consider the investment objectives, risks, charges and expenses of any fund carefully before investing. The funds' prospectuses and, if available, the summary prospectuses contain this and other information about the funds, and are available, along with information on other BlackRock funds by calling 800-882-0052. The prospectus and, if available, the summary prospectuses should be read carefully before investing.
The information on this web site is intended for U.S. residents only. The information provided does not constitute a solicitation of an offer to buy, or an offer to sell securities in any jurisdiction to any person to whom it is not lawful to make such an offer.
FOR MORE INFORMATION: www.blackrock.com
©2013 BlackRock, Inc. All Rights Reserved. BLACKROCK, BLACKROCK SOLUTIONS and iSHARES are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.
BlackRock is a registered trademark of BlackRock, Inc. All other trademarks are the property of their respective owners.
BlackRock's senior strategists discuss their views on key market and investment topics, answer the critical questions on investors' minds and point to where they see opportunities in the market.