David L. King, a veteran portfolio manager, takes a strikingly holistic view of income investing, whether it’s common stock dividends, convertible bonds, or other investments that pay a stream of cash.
“The confusion on specialization is that the rules are different” for the various types of income investment, “but the analysis is not different,” he said in an interview this week.
King’s advice for dealing with rising interest rates: Be flexible and take a longer-term view.
“If you have a role for fixed income in your portfolio, you don’t want to abandon it if the [10-year] Treasury happens to go from 2.9% to 3.3% in a week or two, which it might,’” says King, who heads the income and growth strategies team at Columbia Threadneedle Investments.
In such a scenario, Treasury holders would take a hit due to a price decrease. (Bond yields and prices move in opposite directions.)
The 10-year U.S. Treasury yield has increased in fits and starts this year, having recently been unable to surpass 3% for very long—although King does expect rates to move higher. It was at 2.92% on Wednesday.
King helps run the $700 million Columbia Flexible Capital Income fund (CFIAX), among other portfolios. As of May 31, about a third of the fund’s assets was in equities. Another 60% of the portfolio was split pretty evenly between convertible bonds and other fixed-income credits, with the rest in cash.
King maintains that higher rates can be an opportunity for investors, citing an example of holding five-year Treasuries: “When they expire, the rate is higher, and I’ll get a higher rate over the next five years, or I’ll buy some each year.”
King doesn’t see much value in bank loans, whose yields float and are reset regularly, owing to valuation. High-yield spreads remain pretty tight, but he senses better value in that sector among bonds with higher credit ratings and shorter maturities, typically less than eight years—the latter to protect against duration risk.
As for stocks, the “opportunity is more behind us than ahead in terms of income,” he says, adding that it’s much harder nowadays to find a company whose dividend yield exceeds that of its 10-year corporate bond.
Traditional dividend sectors such as utilities and consumer staples “are likely to be more interest-sensitive,” he says. “The problem with them is not the income or the growth of the income—but the stock prices are likely to be at risk if you [have] a good economy with rising rates.”
Finding income when rates are rising
King, however, does see pockets of opportunity in equities for income investors, including mid-cap names such as Six Flags Entertainment (SIX). The regional theme-park operator’s stock was yielding 4.3% recently. He likes that the company is selling more season passes and has been growing international operations.
King also holds some traditional technology stocks such as Microsoft (MSFT), its so-so yield of 1.7% notwithstanding.
“Microsoft’s dividend growth has been robust, and it has contributed to it being a good stock,” he says. His other technology holdings include KLA-Tencor (KLAC) and Lam Research (LRCX).
Another area where King sees opportunity is convertible bonds, which typically convert to common stocks at a predetermined price. That “the convertible market is yielding about 3% isn’t especially exciting,” he says. But these bonds, he adds, aren’t closely tied to the Treasury yield curve. And they can trade more like growth stocks, which can help diversify a portfolio.
One of his holdings is a convertible issued by PTC Therapeutics (PTCT) with a coupon of 3%. It trades at about par, or its face value.
“Take the risk where you are getting the return,” he says in summing up his approach.
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