Income and inflation: What you should know

A multi-asset approach may help you face uncertainty in the second half of 2021.

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Key takeaways

  • Multi-asset income strategies may help investors meet their needs for income in the second half of 2021 despite interest rate uncertainty and the high prices of many stocks.
  • In exchange for higher income, some assets that these strategies invest in may experience more volatility than traditional income investments. In an inflationary environment, however, strategies that can invest in a variety of income-oriented assets may offer both higher income and better capital preservation tools than traditional fixed income investments.
  • High-yield bonds, floating-rate loans, dividend-paying US and international value stocks including energy and gold producers, master limited partnerships (MLPs), and real estate investment trusts (REITs), are among the investments that may offer income opportunities in the second half of 2021.
  • Professional investment managers may find opportunities when markets misprice these assets due to excessive pessimism about the future.

With the economy growing, unemployment falling, and stock prices rising, many growth-oriented investors are enjoying what feels like a sunny day at the beach. But for those who focus on earning dividend and interest income from their portfolios, the forecast remains as cloudy this summer as it was during the winter and spring. Interest rates are still near record lows and there may appear to be few viable alternatives to pricey and potentially volatile stocks. Further complicating things is the return of inflation after a decades-long nap and growing uncertainty about whether higher consumer prices will force interest rates upward and hurt the prices of many assets.

The good news is that opportunities do exist for those who know where to look and how to manage the risks of doing so. In today's environment, a professionally managed approach to income investing that can seek opportunities in a variety of asset classes may help investors achieve their income goals.

The forces that drive markets are always in motion and 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 means that diversification, research, and risk management matter. It's also why 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 those with fewer options to choose from.

Scanning the horizon for income opportunities

Inflation is one of the clouds that income-seeking investors have watched grow bigger and darker since the start of the year and that change in the weather is affecting opportunities in several popular income-producing asset classes. Inflation is a concern for fixed income investors in particular because it may lead to higher interest rates, which in turn cause the prices of existing bonds to fall. It's unclear whether the current rise in inflation is merely a passing phase or something that will be with us for a while, but rising consumer prices increase the possibility that interest rates may also rise and corporate earnings may fall during the second half of 2021. Against this backdrop, it's important to determine which income-oriented asset classes may be able to withstand the effects of inflation and which companies may be most able to maintain earnings.

Even with yields on high-yield bonds near record lows, they continue to offer higher interest payments than those offered by Treasury or investment-grade bonds and their valuations remain relatively reasonable. Of course, their higher interest payments reflect their lower credit ratings and imply higher volatility and risk of default. But the credit quality of the overall high-yield market is actually higher now than it was a year ago as many profitable and well-managed companies such as Ford and Kraft have seen their credit ratings lowered into high-yield territory.

Still, high-yield bonds do pose somewhat more default risk than other types of bonds, but they are less exposed to the risk that rising interest rates will reduce bond prices. That's not the same thing as being entirely immune to the risks from an unexpected rate rise, though. You can understand how vulnerable a bond is to rate risk by looking at its duration, a measure of how likely its price is to change in response to interest rate moves. Currently, duration in the high-yield market averages 3.9 years. That compares to less than 6 months in the floating-rate debt market.

For those worried about higher rates, floating-rate secured term bank loans may offer an attractive alternative to bonds with similarly high yields in the second half of 2021. That's partly because, unlike bonds which pay fixed rates of interest, the amount of income an investor receives from these loans rises when interest rates go up. This feature makes floating-rate debt attractive to investors at times when rates are rising and it contrasts favorably with bonds whose prices drop when rates rise. Remember though, like high-yield bonds, floating-rate loans are sub-investment-grade assets that may be more volatile and present higher credit risk than investment-grade corporate and government bonds.

Dividend-paying value stocks from Europe, Japan, Canada, and the US are another potential source of income in the second half of 2021. Attractive opportunities may exist in the stocks of companies including oil and gold producers, clean-energy yieldcos, banks and non-bank financial firms such as asset managers, and industrial companies. These stocks are paying healthy dividends and may be less potentially volatile than other stocks, though significantly more volatile than corporate or Treasury bonds. They're also inexpensive by historical standards because investors have focused on growth stocks and have been willing to pay a premium for growth. Many stocks of non-US companies offer both relatively high dividend yields and low valuations that reflect the slower pace of the COVID-19 economic recovery outside the US. Countries such as Canada, for example, are only starting to reopen their economies.

Real estate investment trusts in the US and Canada may also offer attractive and steady (or even rising) dividends plus the potential for capital appreciation as more people return to offices, stores, and leisure activities. REITs can grow their earnings by raising rents and they pay dividends that are higher than the yields of both the S&P 500 and investment grade bonds. Despite their improving fundamentals, some REITs are still being underpriced by the market and that's creating opportunities for skilled managers who practice careful security selection.

Master limited partnership (MLP) dividends are another interesting source of income, though investing in them--like many high-yielding assets--is best left to professional managers. MLPs pay the highest yields of any income-oriented asset class. Like REITs, MLPs operate real properties, mostly oil and gas pipelines, and many also continue to be mispriced by the market. While other energy-related assets such as high-yield energy company bonds have rallied as demand for energy has recovered, that recovery has not yet reached the MLP market so valuations remain attractive. MLPs could also benefit if corporate income tax rates go up because as partnerships, rather than corporations, they have tax advantages that would become increasingly valuable in a higher tax environment.

Finding ideas

Investors interested in multi-asset income 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 funds

  • Fidelity® Multi-Asset Income Fund (FMSDX)

Non-Fidelity funds

  • BlackRock Multi-Asset Income Portfolio (BAICX)
  • Invesco Multi-Asset Income Fund (PIAFX)

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.

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