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Key takeaways
- Even in a rising interest-rate environment, some global bond sectors remain resilient and may actually benefit from increased inflationary pressures.
- Defensive equity sectors and dividend payers may be poised to outperform the broader market if elevated inflation persists and/or the global economy sputters.
- Equity, fixed income, and multi-asset investment strategies that are both robust and flexible could allow investors to capture overlooked income and return opportunities in today’s volatile, uncertain market landscape.
Income investing is not just about “chasing yield”
Global markets have remained volatile amid central bank rate hikes, stubbornly high inflation, and ongoing geopolitical tensions. To help navigate these and other risks, many investors have recently turned their attention to investments that can potentially generate consistent income and steady total returns.
This is where income investing comes into the spotlight, which may seem like a straightforward enough concept. However, some investors may not realize that investing for income is not simply about “chasing yield” — in part because the highest-yielding assets may not always be the most attractive. For example, many higher-yielding companies could become hampered by a lack of capital when global markets enter periods of turmoil.
That’s why investors should consider taking an active, multifaceted approach to understand the “big picture” of income investing. Robust, yet flexible, investment solutions spanning across asset classes — including equity, fixed income, and multi-asset strategies — could allow investors to capture overlooked pockets of income and return opportunities, even under volatile market conditions.
REITs may be well placed to outperform going forward
In my view, defensive equity sectors and dividend-paying assets look likely to outperform the overall market in the period ahead, potentially helping investors weather the impact of high inflation on their portfolios. In particular, an allocation to real estate investment trusts (REITs), which have historically often outperformed both equities and bonds (Figure 1), could make sense these days. REITs may also be an excellent source of dividend income.
Figure 1
In the post-pandemic era, new investment income and return opportunities have emerged across different segments of real estate, including companies operating cell towers, data centers, warehouses, self-storage facilities, and health care properties. Moreover, the outlook appears bright for the real estate sector as a whole, which has a high proportion of defensive cash flow and may help hedge against inflation. Many landlords remain well positioned to maintain their rental income streams given the strength of renters’ demand, particularly in markets such as the US.
Rate hikes may be a tailwind for certain bond sectors
True to form, rising inflation and interest rates worldwide have posed stiff headwinds for many traditional rate-sensitive bonds this year. However, because not all bonds are alike, these same headwinds may act as tailwinds for other types of bonds. Indeed, some fixed income sectors have remained quite resilient and may even benefit from increased inflationary pressures. Examples include floating-rate bank loans and Treasury Inflation-Protected Securities (TIPS), which have continued to hold up well in the face of higher rates and inflation.
In addition, against today’s challenging macro backdrop, high-yield corporates, convertible bonds, securitized credit, and emerging markets (EM) local debt may outperform many conventional, investment-grade fixed income sectors. Residential mortgage-backed securities (RMBS) may also be worth a look, as the collateral typically benefits from rising home prices.
EM local debt may be more susceptible to global geopolitical factors than other fixed income sectors but should not be written off on that basis alone. Many EM central banks are well ahead of the Fed in hiking rates to help blunt inflation, while high commodity prices are a boon to some EM commodity exporters.
Multi-asset investments may be another piece of the puzzle
Income-oriented investors might also consider diversified, multi-asset investment strategies that leverage both traditional and complementary sources of income (such as real assets, options, and other fixed income assets). For example, covered-call options on single stocks may provide additional income potential, as might selling put options on high-quality stocks.
Prudent security selection is critical when investing in options. Trading options over corporate earnings announcements should be avoided in particular, as markets are likely to experience more extreme volatility around companies’ quarterly results.
Expect markets to remain volatile this year and into next
Lofty inflation, economic uncertainty, and central banks’ responses will likely continue to impact global markets through 2022 and perhaps into 2023. Geopolitical events this year, particularly the conflict in Ukraine and sanctions on Russia, have dealt a heavy blow to supply chains worldwide, causing shortages in agricultural, metals, and energy commodities and further stoking inflation. Higher energy prices and potential energy rationing in some regions could also weigh on various economies’ paths to recovery.
Harness the power of active management
With so many dynamic moving parts and so many different types of assets to choose from, investors shouldn’t go it alone. Partnering with a capable, experienced active investment manager may enable investors to capitalize on compelling income opportunities, while also effectively managing portfolio risk. That’s the power of active management.
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