Multi-asset income: pursuing higher yields in a higher-inflation environment
Generating income from fixed-income assets alone has become dramatically more difficult in recent years due to a prolonged decline of interest rates. At the same time, protecting the real value of capital is increasingly important in today’s higher-inflation environment. Against these two forces, multi-asset solutions can help investors find a balance of sustainable income while limiting the inflation-accelerated erosion of a capital base.
Today’s low-yield/high-inflation environment is making the search for meaningful returns more and more difficult. With 10-year U.S. Treasury bond yields of around 1.42% as of December 20, 2021, and inflation of 6.80% over the 12 months ended November 2021, fixed-income investors are feeling the need to expand their investment universe beyond traditional core and core-plus bond approaches.
Treasury bond yields are down sharply from their peak in the early 1980s
10-year U.S. Treasury bond yields, January 1962–December 2021
Source: U.S. Federal Reserve Bank of St. Louis, John Hancock Investment Management, December 2021.
Broadening the investment landscape through a multi-asset approach
A multi-asset approach to income investing may help investors out of the double bind of yield-starved markets and stubbornly high inflation. By using a multi-asset portfolio, investors can gain access to a wider range of income-generating and capital growth assets, as well as greater depth and diversification within asset classes.
Selecting a manager whose approach blends multiple investment styles—both active and passive—can produce portfolios that reduce costs through the use of passive investments for broad market exposure while deploying active management in instances in which deliberate asset selection is needed, such as fixed income.
A diversified, active approach to fixed income
We believe that any income portfolio should retain a core exposure to Treasury bonds for stability and risk mitigation. However, in a prevailing low interest-rate environment we see opportunity in diversified segments of fixed income, namely high-yield corporate bonds and emerging-market (EM) debt.
U.S. high-yield bonds and emerging-market debt provide active investment management opportunities
Yield for corporate high yield bonds, U.S. dollar-denominated emerging-market debt and U.S. bonds aggregate, June 2003–November 2021 (%)
Source: Bloomberg, Manulife Investment Management, December 2021. U.S. corporate high-yield bonds are represented by the Bloomberg U.S. Corporate High Yield Bond Index, which tracks the performance of the U.S. dollar-denominated, high-yield, fixed-rate corporate bond market. Emerging-market USD aggregate is represented by the Bloomberg EM USD Aggregate Bond Index, which is a flagship hard currency EM debt benchmark that tracks USD-denominated debt from sovereign, quasisovereign, and corporate EM issuers. U.S. aggregate bonds are represented by the Bloomberg U.S. Aggregate Bond Index, which tracks the performance of U.S. investment grade bonds in government, asset-backed, and corporate debt markets. It is not possible to invest directly in an index. Past performance does not guarantee future results.
High yield and emerging-market debt spreads are volatile compared with other fixed-income assets
While some may see this volatility as a downside risk, we see it as signaling an important condition that will periodically yield opportunities for active investment management to enhance income through deliberate asset selection balanced with prudent risk management.
EM debt currently provides a compelling investment case, according to our research
Many EMs are driven by some aspect of the commodity cycle, which adds differentiated returns to a portfolio when compared with traditional Treasury bonds. Moreover, EM debt typically performs well in an environment in which the U.S. dollar is broadly weaker, which we believe is the environment we’re entering relative to historical levels.
A further interesting and compelling opportunity persists: Currently, EM debt offers high yields and relatively higher quality compared with the U.S. high-yield bond universe. While EM sovereign debt generally is of higher quality relative to high-yield bonds, it also ordinarily presents lower-yielding opportunities. However, as of the current writing, EM debt is trading on par with high-yield bonds, a relatively rare occurrence not likely to persist but exactly the type of moment in which active management in multi-asset fixed income can pursue a risk-aware yield advantage.
Higher-quality emerging-market debt yields are trading in line with high-yield bonds
Yield for U.S. corporate high yield bonds and U.S. dollar-denominated emerging-market debt, June 2003–November 2021 (%)
Source: Bloomberg, Manulife Investment Management, as of November 2021. U.S. corporate high-yield bonds are represented by the Bloomberg U.S. Corporate High Yield Bond Index, which tracks the performance of the U.S. dollar-denominated, high-yield, fixed-rate corporate bond market. Emerging-market USD aggregate is represented by the Bloomberg EM USD Aggregate Bond Index, which is a flagship hard currency EM debt benchmark that tracks U.S. dollar-denominated debt from sovereign, quasisovereign, and corporate EM issuers. It is not possible to invest directly in an index. Past performance does not guarantee future results.
Capital growth within an income portfolio
Capital growth is given particular attention in income-generating portfolios as investment returns are typically drawn as income—and often as a percentage of the total portfolio. At minimum, capital preservation must be achieved to protect the sustainability of income over the long term but, ultimately, capital growth is an objective.
In general, and especially in periods of low bond yields, equities outperform inflation more regularly and consistently than bonds.
On a price return basis, equities have consistently and meaningfully outperformed inflation, while corporate bonds haven't kept pace with inflation
Price return of high-dividend equities, corporates, and core CPI, January 2012–October 2021
Source: Bloomberg, Manulife Investment Management, as of November 2021. U.S. high dividend equities are represented by the price return of the MSCI USA High Dividend Yield Index, which tracks the performance of equities with higher dividend income and quality characteristics that are both sustainable and persistent. U.S. corporate price returns are represented by the price return of the ICE BofA Corporate Master Index, which tracks the performance of publicly issued, fixed-rate, nonconvertible, investment- grade, U.S. dollar-denominated corporate debt having at least one year to maturity. It is not possible to invest directly in an index. Past performance does not guarantee future results.
Equities are a riskier asset class, with higher volatility than in fixed income
Although equities have historically generated less income than bonds, they can grow capital as inflation rises, even without reinvesting dividends. Bonds generate higher income but are unlikely to materially grow a capital base, especially in a higher-inflationary environment.
A versatile portfolio suited to multiple investor types
Multi-asset income investing provides a unique set of tools with which to solve the two specific challenges investors face: finding higher yields in a low-yield environment and protecting an asset base through capital growth amid higher inflation. Allocating between fixed income and equity to generate an income while simultaneously growing capital requires deliberate and thoughtful asset allocation.
With an inherently more flexible approach than stand-alone, single asset class funds, we believe multi-asset approaches can provide an optimal solution for investors who want income combined with capital growth in a risk-aware framework. Furthermore, multi-asset income may be appropriate for investors seeking to reallocate from cash into an approach that can balance risk management with an investment strategy that offers more maneuverability in finding returns.
The views expressed in this material are the views of the authors and are subject to change without notice at any time based on market and other factors. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index, and is not indicative of any John Hancock fund. Past performance does not guarantee future results.
Investing involves risks, including the potential loss of principal.
Diversification does not guarantee a profit or eliminate the risk of a loss.