Income + growth: investing to have your cake and eat it too

Key takeaways:

• Many investors entered 2023 bracing for financial markets to deliver additional declines, but declines never came. Instead, equity markets around the globe have steadily marched upward, many generating double digits returns year to date.
• This trend has sparked many questions around the continued strength of these market rallies and has increased interest in outcome-focused strategies to adapt to this new regime.
• Evolved strategies, capable of providing both an enhanced income stream via option-writing and equity market participation may provide just the opportunity to position clients to achieve their goals in the current market environment.

Despite entering the year bruised and battered from synchronized declines in equity and bond markets (and expectations of an imminent US recession), 2023 has been anything but scripted. Equity markets are up substantially year to date and real yields are at their highest point since 2009.¹ But answers for investors on how to position portfolios for what may come next remain scarce. 

In our view, markets are offering participants a rare opportunity to have their cake and eat it too. Equity investors are often forced to choose between upside potential (having their cake) or high dividends (or eating it). Option-based strategies provide exposure to differentiated sources of income, dividends and option premiums, while maintaining market participation. The intent of these strategies is to give investors options, with dual goals of income generation and equity market growth in mind, to help them achieve their long-term financial objectives.

Can a good thing last? A case for equity market optimism

Despite apprehension among some investors going into 2023, this year has reinforced the age-old maximum that time in the market can be more critical than trying to time the market. Those that reduced equity exposure or avoided equity markets all together in 2023 – many opting for cash returns – have missed record equity market rallies year to date.

Figure 1: Equity vs. Treasury performance year to date
Total returns year to date

For many market participants, the AI hype around a small number of US mega cap technology firms that have led outsized returns (several being the largest companies in the world today), has them discounting a potential broadening of the equity rally – which may be premature. Ex-mega cap, U.S. equities have risen 5.2% this year, sparking divisive opinions on whether the equity rally will continue to climb through year end, or whether this narrow rally may be set to cool.²

Outside the US, global equities seem to imply a broadening of the rally may already be underway. The MSCI All Country World, the Japan Topix, and the MSCI Developed Equity Index are all up more than 15% year to date, and rather than narrow tech leadership, its cheap value stocks that have driven returns in these markets.³ The broadening of these advances may suggest that stocks, in the US and outside, could keep climbing.

Despite the evidence year to date, many investors remain skeptical on the path for equities ahead, concerned about the impact of a higher for longer rate environment. The recession investors have long anticipated has yet to appear, but the possibility has already driven portfolio overweights to short-term fixed income assets and underweights to equities. While this may have logic for shorter-term investors, we believe investors focused on the long term may want to remain concentrated on how best to achieve their financial goals.

Given higher levels of inflation, investors have been driven to evaluate total return objectives to ensure their portfolio is keeping pace. U.S. large cap stocks have beaten inflation more often than cash over all time horizons, from one to 20 years (see Figure 2 below). Over short-term periods, equities have underperformed inflation. But looking over longer rolling periods, equities have consistently delivered inflation-beating returns.

Figure 2: Percent of periods equities outperform inflation

But what if an equity market correction is in store? What could investors do to position against equity beta, yet still participate should equity markets continue to rally?

An income premium with options

Innovative approaches to total return may be what’s needed to navigate today’s markets, that may experience slower growth ahead if inflation and interest rates remain elevated. Deconstructing returns into distinct sources: dividends, options premiums and market participation can provide investors with better perspective to assess the right tools to tackle each of today’s market challenges. Equity options-based solutions can be one tool investors can leverage to pursue specific outcomes; and complement traditional asset class exposures in portfolios. 

BlackRock’s suite of outcome-oriented products focuses on addressing investor objectives, and provides tools for fluctuating market dynamics. Strategies such as BlackRock’s Advantage Large Cap Income ETF (BALI), seek to generate a higher level of income from two sources - targeting a dynamic basket of dividend paying stocks and an option premium from selling call options on the S&P 500 Index. The stock selection process targets high quality large cap equity dividend payers, based on data-empowered insights, triangulating securities based on fundamental, sentiment and macroeconomic insights. Used in conjunction with a dividend optimization model, the strategy has the ability to capture higher levels of income than traditional dividend strategies. BALI also will sell one-month call options on the S&P 500 Index above the current strike price level in an attempt to generate an additional source of income, while maintaining equity market participation. Using this innovative approach to generating income, the strategy receives income from dividends on the equities, as well as the potential premium received from writing options to generate higher levels of income. 

This structure allows equity options-based strategies to seek outperformance in down markets, due to lower equity market beta. In more mixed environments, additional income from selling call options will also serve to offset equity declines, while the strategy will still participate in limited equity market upside should an equity rally take hold. A diversified income source, coupled with continued market participation provides clients with a more complete set of tools to meet their evolving investment needs and better positions them to have their cake and eat it too regardless of the market environment.

Access exclusive tools and insights

Explore My Hub, your new personalized dashboard, for portfolio tools, market insights, and practice resources.

Get access now