Mid-year income investing outlook: How to fight inflation

Multi-asset strategies may help protect against inflation while also earning income.

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Key takeaways

  • In a time of high inflation and volatile markets, strategies that can invest in a wide variety of assets may offer higher income and better capital preservation than traditional bonds.
  • Adding a multi-asset real return strategy to your income-oriented portfolio may help protect its purchasing power against inflation.
  • In exchange for higher income and inflation protection, some assets that these strategies invest in may experience more volatility than traditional income investments.
  • Commodities, floating rate loans, and real estate are among potential inflation-fighting income investments for the second half of 2022.
  • Professional investment managers have the research resources and investment expertise necessary to identify mispricing and manage the risks associated with these higher-yielding securities.

So far, 2022 has been brutal for many investors who seek to earn income from their savings. Policies enacted in response to both the war in Ukraine and the ongoing COVID pandemic have helped push consumer prices to their highest levels in decades, eroding the value of cash in savings and money market accounts. In response to that high inflation, the Federal Reserve is raising short-term interest rates, which has helped drive bond prices down.

After a first half when little seemed to go right, income-seeking investors may feel like football players trying to adjust their game plan before the second half starts. In the months ahead, rates are likely to rise further but even the most optimistic forecasters don’t see inflation quickly returning to the low levels Americans have enjoyed for the past 4 decades.

Fortunately, adjustments are possible and opportunities are being found by professional investors who manage multi-asset strategies that have the flexibility to choose from among a variety of assets to generate income and fight inflation. They recognize that market conditions constantly change and the investments that deliver the highest returns today may not be the ones that do so next month or next year. Because of this, strategies that have a bigger menu of investment options to choose from may be able to deliver more consistent returns and a better balance between risk and return than those with fewer choices.

“We think about combining bond income, equity income, and inflation protection income,” says Ford O’Neil, who, along with Adam Kramer, manages Fidelity Strategic Real Return Fund (FSRRX) and Fidelity Multi-asset Income Fund (FMSDX).

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High inflation is a particular concern for income-oriented investors because it attacks the assets they rely on most. Rising prices eat away at the purchasing power of cash in savings, money market accounts, and CDs. Inflation also hurts bonds because it leads to higher interest rates, which can cause bond prices to fall. That doesn’t mean cash and bonds are useless when inflation is high: They're still important parts of a well-balanced portfolio and their yields may rise along with rates, but right now they need help from other assets for protection.

Although stocks can provide protection against inflation, the volatile performance of major stock indexes so far this year strongly suggests that other alternatives may be worth considering if you’re at a point in life where you want less stock volatility. Instead of stocks, O’Neil and Kramer suggest considering commodities, floating rate assets, and real estate as accompaniments for a core income-producing portfolio to help provide protection from inflation.

Higher inflation and interest rates are increasing the attractiveness of floating rate debt including loans. Unlike bonds that pay fixed rates of interest, floating rate assets pay interest at rates that adjust periodically, based on a publicly available, short-term interest rate. They offer potential inflation protection and a hedge against the rising interest rates that inevitably accompany inflation. That means floating rate assets are less likely than most fixed income investments to lose value when inflation and interest rates rise. O’Neil says he allocated about 25% of the real return fund’s assets to floating rate loans and says yields on loans are near 7%. While past performance is no guarantee of future results, floating rate loans historically have performed better than longer-duration fixed income bonds in a rising-rate environment. Remember, though, that 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.

Commodities, REITs, and TIPS

Commodities such as oil, precious metals, corn, wheat, and soybeans have historically risen in price when inflation is rising and other investments are suffering. Commodity prices rose sharply in the first half of 2022, due in part to supply disruptions caused by the war in Ukraine and resulting sanctions by western governments against Russia. O’Neil and Kramer allocated roughly 30% of their fund’s assets to a combination of commodity futures contracts and stocks of companies such as gold miners that produce commodities. Because they have the flexibility to invest in both futures contracts and stocks, Kramer and O’Neil were able to identify a wider variety of opportunities within commodities. Says Kramer, “There's been a big dislocation so far this year between commodity equities and futures. There's been bad news priced in to the prices of some commodity stocks, which is creating opportunities to buy these assets at attractive prices relative to commodity futures.”

Real estate investment trusts (REITs) and real estate debt may also help income-seeking investors fight inflation. REITs offer attractive and steady (or even rising) dividends plus the potential for capital appreciation. REITs can also grow their earnings by raising rents. Despite their inflation-fighting fundamentals, though, Kramer says that REITs can turn volatile when yields on 10-year treasury bonds rise quickly and the market is beginning to price in worries about how rising 10-years may affect REITS in the second half of 2022. While that sounds bad for investors, he believes the market may be overreacting. REITs have sold off, but could regain some ground if markets stabilize, so he's holding a modest overweight position. To get exposure to the inflation-fighting power of real estate while offsetting the potential volatility of REITs in a rising rate environment, Kramer and O’Neil also suggest considering real estate debt.

Besides commodities, loans, and real estate, Treasury Inflation-Protected Securities (TIPS) can also play a role in an inflation-fighting income strategy. To help reduce the risk that inflation poses to bondholders, the US Treasury created these bonds whose interest payments are designed to rise when inflation does. They are available in 5-year, 10-year, and 30-year maturities. The inflation protection offered by TIPS comes at a price, though. TIPS are more expensive than conventional Treasury bonds and higher-priced bonds yield less than lower-priced bonds. O’Neil believes there are more compelling options for getting income and inflation protection. “TIPS offer safety and a chance to stay even with the CPI, but little else that you couldn’t get elsewhere. You're guaranteed no real return if you buy them today, and we know we should be able to do better than that with other inflation-sensitive assets.”

Finding ideas

Investors interested in multi-asset income and real return 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 Fidelity.)

Multi-asset class income funds

Fidelity funds
Fidelity® Multi-Asset Income Fund (FMSDX
Fidelity® Strategic Real Return Fund (FSRRX)

Non-Fidelity funds
BlackRock Multi-Asset Income Portfolio (BAICX)
Eventide Multi-Asset Income Fund (ETAMX)
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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