SHAREHOLDER PERSPECTIVES

A multi-asset approach to
income investing

Dec 22, 2016

Income investors have taken to the extremes: reaching to the riskiest corners for yield while also piling up cash, but they are missing out. Find out how.


If you’re investing for income today, or at any time in the past few years, you know it’s an endeavor fraught with uncertainty, perhaps even disappointment. And this may very well have you on an emotional risk-on/ risk-off seesaw — trying to achieve a decent amount of income without indecent risk.

BlackRock has observed that a convergence of market and behavioral dynamics has caused many investors to operate at the extremes as they seek income: They are taking undue risk in a reach for yield and at the same time hoarding cash.

Neither the full-throttle risk nor the “no-risk” approach is optimal. Consider that for an equal amount of income, investors need to take more than double the risk they did 10 years ago. (See chart below).

Now and then: same yield, higher risk
Yield and risk, 2005 vs. 2015

Now and then: same yield, higher risk

Source: Morningstar. As of 12/31/15. Risk represented by 10-year annualized standard deviation. Hypothetical 3% Income Portfolio comprised a 81% allocation to Money Funds and 19% allocation to Core Bonds in 2005, and 84% Core Bonds and 16% High Yield Bonds in 2015. Hypothetical 4% Income Portfolio comprised 55% Money Funds, 30% Core Bonds and 15% High Yield Bonds in 2005, and 63% Core Bonds and 37% High Yield Bonds in 2015. Hypothetical 5% Income Portfolio comprised 30% Money Funds, 40% Core Bonds and 30% High Yield Bonds in 2005, and 41% Core Bonds and 59% High Yield Bonds in 2015. Money Funds, Core Bonds and High Yield represented by the Morningstar Taxable Money Market Funds category, Barclays Aggregate Bond Index and Barclays High Yield 2% Issuer Capped Index, respectively.

There is also risk in the seemingly safe “run to cash” scenario — in the form of opportunity lost by not investing those dollars in higher-potential opportunities as well as the tangible loss of growth and purchasing power after the effects of inflation and taxes.

Fortunately, a middle ground exists between these two extremes. I think a managed, multi-asset approach to income investing that invests specifically for attractive yield at lower levels of volatility makes good sense today. As the portfolio manager of such a strategy, I’d offer the following observations and considerations for fellow income seekers:

Favor shorter duration

Duration, or interest-rate sensitivity, of bond investments has steadily risen recently as investors have piled money into fixed income. Longer-duration assets may be particularly at risk as the Federal Reserve proceeds with interest rate hikes. Floating-rate securities or short-term fixed income might offer a better cushion in episodes of rising rates.

Use volatility

Equity market volatility, as measured by the VIX, touched its lowest level in 42 years in August. And it hasn’t taken off as much as might be expected despite looming political uncertainties domestically and abroad. Times of low volatility can be opportune for buying an equity hedge while it’s inexpensive, to target some protection on the downside. At times when volatility spikes, pricing dislocations can occur in otherwise attractive assets. Market corrections, particularly when indiscriminate, can be times to look for buying opportunities.

Pick your places in high yield

Some pockets of high yield look better than others from a risk/reward standpoint. For example, the yields on CCC-rated high yield bonds are quite low on a 10-year basis given the historically higher default rates in this low-quality portion of the market. In our opinion, there’s not enough yield to compensate for the risk. On the other hand, in a slow but steadily growing economy, shorter-maturity, higher-quality high yield (BB and B rated) looks like a potentially interesting place — not for price appreciation, but for consistent cash flow. We would apply the same selective thinking to bank loans and other areas of credit fixed income.

Focus on dividend growers

Central bank policy has implications not just for interest rates and bond prices, but for pockets of equities. These are typically incomeproducing equities, such as utilities and consumer staples, the “bond market proxies.” Stock dividends are still an attractive source of income, but we would not target the highest yielders now. We prefer stocks with a history of cash-flow generation and dividend growth.

With a number of important events exacerbating uncertainty in the short term, we think it makes sense to keep risk at the low end of the continuum now. This might mean lower exposure to equities and some forms of credit. However, the Holy Grail for income investors today is selectivity and an active, eyes-wide-open approach to managing opportunities and risk.

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Michael Fredericks
Lead Portfolio Manager of BlackRock Multi-Asset Income Fund
Michael is responsible for the development and management of asset allocation strategies for retail clients.