With the economy emerging from recession, the November elections in the rear-view mirror, and hope rising for COVID-19 vaccines, many investors may look forward to 2021. But for those who focus on income, the future may look less bright. While the S&P 500 hit record highs in 2020, interest rates are near record lows and income seekers may doubt there are alternatives to pricey and potentially volatile stocks.
The good news is, despite low rates, opportunities exist for those who know where to look and how to manage the risks of doing so. In 2021’s environment, a professionally managed, tactical approach to income investing that seeks opportunities in a variety of asset classes may help investors achieve their income goals.
The role of uncertainty
Uncertainty about the future may be one key to finding income opportunities in the new year. That’s because markets sometimes underprice assets based on unknowns, despite those assets’ ability to generate income. And while uncertainty about the coronavirus, the US elections, and the economy may be lower in 2021, it’s worth remembering that economic and political uncertainty also seemed to be diminishing as 2019 came to a close.
A year later, the COVID-19 pandemic has overturned long-held assumptions about economics, markets, government, and life itself. New uncertainties face investors about policies that may come from Washington, rising geopolitical tensions, and more. That means there’s still plenty to cause markets to temporarily misprice assets and overlook how much investors might earn over a longer term on those assets.
Professional managers can identify mispricings and manage the risks that often accompany higher-yielding assets. Rather than overreact to uncertainty, they can seek assets they believe have the potential to outperform when uncertainty eventually diminishes.
Where—and how—to look for opportunities
The forces that drive markets are always in motion and 2021 will be no exception. Because market conditions constantly change, the investments that deliver the highest returns today may not be the ones that do so next month or next year. That’s why multi-asset income strategies that can invest across a wide variety of asset classes may be able to deliver more consistent returns and a better balance between risk and return than strategies whose managers have fewer options to choose from.
Where I see opportunities for 2021
Many US and international dividend-paying value stocks can pay healthy dividends and may be less potentially volatile than growth stocks. They’re also inexpensive by historical standards because investors have focused on growth stocks and are willing to pay a premium for them. Attractive opportunities may exist in industries including leisure and travel, financials, industrials, materials, oil tankers, energy, semiconductors, and non-bank financial firms with larger-than-average dividends.
Professional managers with strong credit analysis skills may find opportunities in high-yield bonds. Many bonds with double-digit yields issued by energy and metals companies are currently being mis-priced or ignored. These industries represent 15% of the high-yield market and carry ratings ranging from CCC to BB. Careful analysis suggests some of these bonds may have too much distress priced into them. BB-rated bonds sit one notch below investment-grade BBBs. These bonds currently represent around 55% of the high yield market and they offer higher yields with less interest rate risk than BBBs. Because a lot of uncertainty has been priced into BBs, they could deliver return if markets head higher or preserve capital if interest rates rise or credit spreads widen.
For those managers with the skill to practice careful security selection, emerging market (EM) debt, specifically high-yield EM debt, may also offer opportunities in 2021. Most EM bonds are investment grade, and they have done very well over the last 12 to 24 months, while high-yield EM bonds have been trading at very wide spreads. While this relative spread has narrowed in the last few months, opportunities still exist. Bonds issued by the Mexican oil company Petroleos Mexicanos, known as Pemex, are an example. Mexico’s government supports Pemex because it wants energy independence and Pemex bonds represent almost a quarter of Mexico’s overall debt. As of September 30, 2020, PEMEX bonds accounted for 1.75% of the holdings of the Fidelity® Multi-Asset Income Fund. The spread on these bonds has widened to the point where positive returns are possible as oil markets and the global economy recover in 2021.
Trends that have been creating income investing opportunities in the energy industry may accelerate in 2021 as a new administration with new energy policies moves into the White House. Master limited partnerships (MLPs) could be an interesting source of dividends in 2021, though investing in them is best left to professional managers. These companies mostly operate oil and gas pipelines and other energy industry investments. MLPs could benefit if tax rates go up because as partnerships, rather than corporations, they have tax advantages that would become increasingly valuable in a higher tax environment.
Whether for MLPs, dividend-paying stocks, or high-yield bonds, income investing opportunities in the energy industry are likely to be created by negative sentiment in the markets about long-term future demand for oil and gas and changing government policies. While energy demand is likely to recover as economic activity revives and companies and consumers adapt to the persistence of COVID-19, pressures from governments, including the incoming administration in the US, on industries and consumers to reduce fossil fuel use pose longer-term questions about these industries. Still, careful security selection can yield results because many of these companies have strong balance sheets and can maintain their dividend payments as capital spending declines in the future.
Investors who are concerned about the long-term prospects for fossil fuels may want to consider funds that invest in renewable energy yieldcos. These are C corporations that don't have a tax advantage, but are tied to long-term contracts for renewables such as solar and wind energy. Many of these companies are growing along with the shift toward renewable energy, backed by a new administration in Washington, and they can pay attractive and growing dividends.
Another way to invest in renewable energy is through convertible bonds issued by companies operating in those industries. Many of these companies’ stocks are expensive, and convertible bonds can be an attractive way to get exposure to them. Convertibles offer the potential for capital appreciation of stocks, but also potential downside protection because they are considered bonds that are senior in the capital structure.
Convertible bond prices can fall if interest rates rise and stock prices decline, but they are less sensitive to such changes than both stocks and traditional corporate bonds.
With companies and consumers alike avoiding public places in 2020, shares of many real estate investment trusts that own commercial property were hit hard. But among them are owners of US and Canadian hotels, some strip malls, and some factory outlets who are collecting regular rents, are not burdened by debt, and whose shares are available at attractive prices. Security selection, of course, is very important here, but opportunities exist.
Investors interested in these strategies should research professionally managed mutual funds or separately managed accounts. You can run screens using the Mutual Fund Screener on 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
Fidelity® Multi-Asset Income Fund (FMSDX)
Separately managed accounts
BlackRock Diversified Income Portfolio
The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange-traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.