Core and satellite approaches for income investors

A more versatile income approach

Among the income investing choices available to investors, a multi-asset approach stands out for its versatility in targeting income from a broad set of asset classes, its ability to diversify risk, and the potential to preserve and grow capital over time. It’s an approach that's proved resilient through the past three market downturns, based on historical data¹, making it an investment potentially worth considering as the core component of a customizable core-satellite income investment strategy.

Three pillars of multi-asset income investing

Pillar 1: Income

In pursuing regular and consistent levels of income, multi-asset portfolios tend to invest more broadly within fixed income than typical core bond portfolios. This approach provides greater flexibility to allocate to higher yielding fixed-income securities such as high-yield corporate bonds, bank loans, and emerging-market debt in periods when traditional bond yields are low, while moving to higher quality and/or shorter duration fixed income in periods where interest rates are elevated.

Pillar 2: Growth

While income investors are naturally concerned with the income-generating potential of a portfolio, equities can play a meaningful—at times, critical—role in adding to income returns and seeking to grow capital to ultimately help sustain income. Multi-asset income portfolios actively aim to balance income and growth, investing in assets such as high dividend-paying equities, infrastructure, and real estate investment trusts for diversified income returns and capital growth.

Pillar 3: Diversified risk

One of the benefits of an approach that invests broadly across asset classes is risk diversification, which enables investors to avoid overexposure to any single risk factor. Within a multi-asset framework, risk is actively managed and diversified across interest-rate, credit, equity, and inflation risks, reducing overconcentration to any one of these factors.  

Multi-asset vs. other income approaches

When comparing a multi-asset income approach to other choices available to investors—such as a core bond portfolio or traditional equity/bond balanced fund—it quickly becomes clear how these portfolios have the potential to satisfy multiple investment objectives that are key for income seekers.

What’s more, analysis of historical data¹ shows that these portfolios held up relatively well through significant market volatility and recent downturns.

Weathering market cycles with multi-asset income

Three sharp market downturns have occurred in the past 15 years—the 2008 global financial crisis, the sell-off in 2020 at the onset of COVID-19, and the sharp drawdown that can be attributed to high equity and bond correlations in 2022. Multi-asset income investors weathered these periods relatively well in the face of turbulence, generating 4.7% average annual distributions. Year-over-year income returns remained consistent—only dipping below the often targeted 4.0% annual income once in 15 years.

Historical year-over-year income returns for a benchmark multi-asset income portfolio (%)

Source: Morningstar, Manulife Investment Management, August 2023. Benchmark portfolio is a multi-asset income portfolio with a moderate-to-conservative asset allocation. See disclosures for portfolio composition and representative indexes.

In addition, it’s important to note that investors who were reasonably disciplined with how much they withdrew would’ve grown their capital net of all distributions, despite market downturns.

We analyzed three scenarios based on a lump-sum $500,000 investment into a benchmark multi-asset income portfolio and observed returns over the next 15 years between July 2008 and June 2023. In scenario 1 an investor withdraws all distributions, averaging 4.7% a year. In scenario 2, an investor withdraws 4.0% annual income, reinvesting excess returns. Scenario 3 shows an investor withdrawing 3.0% annually—a level many financial professionals consider prudent—reinvesting excess returns.

Capital growth net of 4.7%, 4.0%, and 3.0% annual income distributions ($)

$500,000 invested between July 2008 and June 2023

Source: Morningstar, Manulife Investment Management, August 2023. Benchmark portfolio is a multi-asset income portfolio with a moderate-to-conservative asset allocation. See disclosures for portfolio composition and representative indexes.

While past performance does not guarantee future results, this historical data shows that multi-asset income portfolios weathered three significant—and markedly different—downturns to deliver consistent income and capital growth, while effectively managing risk.

Recognizing that income investors can have a range of different investment objectives over and above requiring a regular income, we turn our attention to examples of structuring satellite positions around a multi-asset income core to achieve three different outcomes: higher growth, downside protection, and diversification through the use of relatively less liquid investments. 

A core and satellite approach

Potential core and satellite universe

By embracing a multi-asset income portfolio that actively targets steady and consistent income returns, capital growth, and risk diversification, investors can structure satellite positions from a broad universe of other assets to align their investment strategy with their preferred investment goals and outcomes. 

1.         Growth

A core allocation to a multi-asset income portfolio can be complemented with growth-oriented satellites. These could comprise a portfolio of individually picked stocks with sector, size, or style factor bias. It could also involve incorporating different investment vehicles as satellites, such as separately managed accounts.
 

2.         Downside protection

For downside protection, investors can consider allocating to cash or cash equivalents, including certificates of deposit or Treasury bills as potentially optimal complements. Allocating to liquid alternatives or gold for downside protection, or commodities for increased inflation hedging, may also have merit.

3.         Diversifying with illiquid investments

For accredited investors or qualified purchasers, core-satellite investing can be approached through a liquidity lens. A multi-asset income portfolio can serve as a liquid income-generating core, augmented with satellites comprising less liquid strategies such as private credit or equity, and/or farmland and timberland, delivering alternative sources of income and return.

Multi-asset as core: a flexible, customizable approach to income investing

Versatility and flexibility are two defining traits built into active multi-asset income portfolios that we believe make them ideal centerpieces of an income investor’s portfolio. In our view, the potential to deliver consistent income, grow capital, and diversify risks gives multi-asset an edge over other approaches to income investing, which either have high interest-rate risk (in the case of traditional bond portfolios) or may not explicitly target income (a constraint of traditional balanced portfolios).

Similarly, investors can apply the core-satellite investment approach to incorporate different investment vehicles such as separately managed accounts or to structure liquid and less liquid allocations. As an all-round versatile core, we believe income investors are well served by the potential benefits of a multi-asset income approach and that following this approach within a core-satellite investment framework allows greater customization for individual objectives.