- Bad news is priced into some asset classes and sectors, which presents income-seeking investors with opportunities as some economic and geopolitical concerns diminish.
- Multi-asset income strategies can invest in a wide variety of income-oriented asset classes and can take advantage of a wide variety of opportunities.
- We're finding opportunities in convertible bonds, floating rate loans, and dividend-paying stocks, particularly in crude oil and tanker companies, international banks, semiconductor makers, and US broadcasters.
- Less attractive, in our view, are high-yield corporate bonds, preferred stocks, and real estate investment trusts (REITs).
The current US economic expansion is one of the longest on record. But signs suggest its end may not be as near as it appeared even a few months ago. While the coronavirus outbreak has emerged as a new source of economic uncertainty, other risks including US-China trade tensions and Brexit have subsided. What's more, there are no signs of recession in the US, and global growth is reviving.
This combination of lower geopolitical and economic uncertainty and heightened concern over disease is helping make this a good time for tactical multi-asset income investing strategies such as the Fidelity Multi-Asset Income Fund (FMSDX). That's because when markets try to anticipate news events, they may temporarily misprice assets based on those events and overlook other factors such as how much investors might earn over a longer term on those assets.
Rather than overreact to bad news, our team seeks assets we believe have the potential to outperform if the bad news turns out to be not so bad after all. That way, if reality turns out as negative as markets expect, prices shouldn't fall much because investors anticipated bad news. If things turn out better than expected, as they appear to be doing on the trade front, these assets could reward investors with higher prices in addition to interest and dividend income.
For much of last year, markets had been pricing in a higher probability of a recession, but now many headline events are moving in a positive direction for markets and investors. The US and China have reached a truce on trade, Brexit is moving forward, and big European economies such as Germany and Italy show signs of life. Central banks also appear willing to stimulate economies and let inflation tick up. It's not the end of the world as we know it, and as tactical multi-asset investors, we feel fine.
Where we're finding opportunities
Convertible bonds are more attractive than they've been in years. Demand is strong and lots of new issues are coming to market with attractive terms. Last year, 20% of the convertible market turned over as bonds either matured or were converted to stock and replaced by new bonds. This year, 9% of the convertible bond market will mature and 5% to 10% of the bonds in the market could also get converted into stock and leave the market. This reduced supply should help keep prices up and offer new opportunities.
This dynamic of ongoing turnover is part of what makes convertibles unique and attractive. As convertible bonds are converted to stock and leave the market, new issues replace them at lower prices and the market has a natural tendency to keep prices from rising to levels that do not offer value to investors. Indeed, even though prices of other types of bonds have become relatively expensive over the past year, prices for convertible bonds now sit only slightly above their 25-year average. Convertible bond prices can fall if interest rates rise and stock prices decline, but are less sensitive to such changes than both stocks and traditional corporate bonds.
Dividend-paying stocks also look appealing, especially as signs suggest that the current economic expansion may continue for a while. As global growth ticks up and geopolitical concerns fade, we see opportunities in companies that have global exposure and can benefit from faster growth. Another factor that may help is new regulation. Dividend-paying stocks of crude oil and product tanker companies may benefit from a new rule called IMO 2020 that went into effect in January. The rule requires ships to use lower sulfur fuel oil and we believe tanker companies may be entering a prolonged period in which they generate large amounts of cash and can pay high dividends. Tanker stock prices have also been pushed down on the belief that China won’t need as much oil as coronavirus weighs on economic growth. We believe this is an opportunity.
International banks are also attractive, particularly those in European Union countries that may see more growth and inflation. Large European bank stocks have been paying 5% to 6% dividends and prices have been pushed down by geopolitical worries.
We like semiconductor makers as well. They typically have a lot of free cashflow and can pay attractive dividends. Similarly, US broadcasting companies are benefiting from growing spending on political advertising which boosts cashflow and dividend payments.
Opportunities in dividend-paying stocks may also lie outside the US. The difference between the price-to-earnings ratios of non-US companies and US companies is very wide and they have an opportunity to catch up as the difference in economic growth rates between the US and other economies narrows.
Remember, though, stock markets are volatile and can decline significantly in response to issuer, political, regulatory, market, or economic developments.
Floating-rate loans are another asset class currently offering attractive yields at discount prices with relatively little risk from changes in interest rates because loans' yields adjust to keep pace with rates. Yields are attractive today and if rates move higher and recession prospects diminish, floating-rate loans could generate higher returns. Remember, though, the value of the collateral securing a floating rate loan can decline in a recession and the loan can lose value.
Less attractive income investments
Another popular category of income-generating investment, high-yield corporate bonds, looks relatively expensive right now. Bonds with low B and CCC ratings issued by energy companies may represent the brightest spots in high-yield presently. To be sure, bonds of less than investment-grade quality involve greater default risk or price changes due to changes in the credit quality of the issuer and many of the energy companies with these credit ratings were the subjects of bankruptcy fears last year.
Opportunities are also relatively scarce in preferred stocks, real estate investment trusts (REITs), and many types of corporate bonds which all rallied strongly in 2019. Banks that have preferred stocks have healthy balance sheets but presently offer relatively little value or income. REITs fundamentals are strong in the US real estate market, but like preferred stocks, they've had a tremendous rally and now trade at historically high valuations.
Investment-grade and many high-yield corporate bonds, US Treasurys, and other government bonds also have gotten more expensive and less attractive as the market has priced in lower interest rates and a recession. However, longer-dated US Treasurys are still a key component of a multi-asset income strategy and play an important role by helping to provide a cushion if markets turn volatile.
Investors who want exposure to these asset classes should consider professionally managed mutual funds. Fidelity has a number of tools to help investors screen through mutual funds and ETFs for research ideas. You can run screens yourself using the Mutual Fund Evaluator, or in the ETF or stock and bond research areas of Fidelity.com. Below are the results of some illustrative mutual fund screens (these are not recommendations of Adam Kramer or Fidelity).
Multi-asset class income funds
Screen: mutual funds > allocation > 30%-50% equity & SEC yield >2%
Fidelity® Multi-Asset Income Fund (FMSDX)
Emerging market funds
Emerging markets bonds
Screen: mutual funds > taxable bond > emerging markets bonds
Fidelity® New Markets Income Fund (FNMIX)
American Beacon Frontier Markets (AGEPX)
MainStay Candriam Emerging Markets (MGHAX)
TCW Emerging Markets Income Fund (TGINX)