Diversify into other sources of income, both across asset classes and regions
Income’s ability to contribute significantly to long-term returns, alongside other benefits, means that, in our view, investors should continue to keep income front of mind when building portfolios. This is especially true in a more volatile investment landscape, where consistency of returns may be challenged.
However, this doesn’t mean that investors should only target the highest-yielding income-producing asset classes in an effort to generate as much income as possible. While higher-yielding asset classes can have their place in a portfolio, maintaining a well-diversified portfolio is crucial. Some asset classes may not produce much income but bestow other benefits for income-seeking investors, such as capital growth or inflation mitigation.
While bonds are currently an attractive source of income and return enhancement, today’s macroeconomic environment should, however, also prompt investors to diversify into other areas, such as equity income, high-yield bonds, property or REITS, or potentially call option writing strategies. These asset classes can provide income alongside other desirable portfolio characteristics. Equity income is a good case in point. While on the surface, a yield close to 5% in government bonds might look superior to the dividend on high-income equities, we believe an allocation to equity income can help to serve the dual objective of income and capital preservation. What’s more, in environments of rising inflation expectations, equity income has historically been a better hedge than nominal bonds.
In a more uncertain and volatile world, we expect growing divergence between regions and countries, as increasingly dyssynchronous economic cycles lead to an inconsistent global policy landscape, with central banks at different stages of the cycle. In this environment, regional allocations may provide more significant potential for diversification than they have in the past.
For this reason, many investors may benefit from a dynamic investment approach, retaining an element of flexibility so as to navigate new opportunities when they arise.