- Investing in a wide variety of assets may help investors meet their needs for income despite volatile markets and worries about interest rates, inflation, and recession.
- In exchange for higher income, some assets that these strategies invest in may experience more volatility than traditional income investments.
- In an inflationary environment, strategies that can invest in a variety of assets may offer both higher income and better capital preservation than traditional fixed income investments.
- Floating-rate preferred stock, convertible bonds, floating-rate loans, and dividend-paying stocks of oil tankers are among the investments that may offer opportunities.
- Professional investment managers have the research resources and investment expertise necessary to identify mispricing and manage the risks associated with higher-yielding security types.
With stocks in a bear market, bonds coming off their worst first half in history and fear of recession rising along with inflation and interest rates, this may appear a difficult time for investors. However, professional managers who have the flexibility to choose from among a variety of income-producing assets are finding opportunities in beaten-up and beaten-down assets.
Adam Kramer, manager of Fidelity® Multi-Asset Income Fund (FMSDX) looks for opportunities that appear when excessive worry, fear, and pessimism cause others to sell assets that yield income and whose prices will eventually rise. He says that current prices of many assets reflect fears that a recession may be at hand and that rising interest rates could hurt stock and bond prices. “From November until March, the prospect of interest rates moving higher caused investors to sell investment-grade and high-duration assets. Now, the fear of recession is being priced into the markets, though I don’t think we’re there yet.”
The shift from worries about higher rates to fears of a potential slowdown is an example of how the forces that drive markets are always in motion. 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. Says Kramer, “For a long time it’s been stocks, stocks, stocks. This year, though, the best-performing asset class could be something other than great bonds and stocks.”
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. In today's challenging environment, a professionally managed, tactical approach that can seize those opportunities may help income-focused investors achieve their goals.
While higher inflation and interest rates have prompted investors to sell many types of assets, they’ve also increased the attractiveness of floating-rate assets including preferred stocks and 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. That makes them less likely than most fixed income investments to lose value when interest rates and inflation rise. For example, while inflation has been running above 8% so far this year, yields on floating-rate loans have been keeping up with it.
Preferred stocks issued by big banks and utilities offer an attractive alternative to common stocks of these same companies. Preferreds offer income and the potential for capital appreciation regardless of what happens to the underlying stocks. Despite these advantages, they have sold off along with most other asset classes as investors worried first about how higher interest rates would affect them and then about how a recession could affect the financial health of the issuers. However, those sellers may have overlooked the fact that these preferred stocks are actually well-suited to a rising rate environment because the yields they pay rise along with rates.
“I think that floating-rate feature is even more attractive than their low prices and it’s something that the investment-grade bonds issued by these companies don’t offer,” says Kramer. Right now, careful investors can find attractive prices on high-quality preferreds that yield 6.5% and could yield more than 10% if they were to be “called” or bought back by their issuers.
While past performance is no guarantee of future results, floating-rate assets 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.
Opportunities in convertible bonds
The bear market in stocks is also helping create opportunities in convertible bonds. Convertibles not only pay interest, they also reduce some of the potential drawbacks of both stocks and longer-duration bonds. Convertible bonds generally are less sensitive than high-yield or other bonds to the risk higher interest rates may pose. Convertible 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.
“More than 50% of the convertible bonds in the market are trading at prices in the 30 to 80-cent range and as such, these converts are trading more like bonds and may be less volatile than stocks," says Kramer. "These bonds are issued by companies in all industries with a predominance in high-growth software, internet fintech, and renewable energy companies."
But remember that the convertible bond market is both small and specialized, and conditions in it can change quickly. This is because unlike other asset markets, the makeup of the convertible market is constantly changing as existing bonds get converted to stock and leave the market while new bonds with different features take their place.
Opportunities in bonds and value stocks
Kramer also says that "High-yield bond yields are now exceeding the rate of inflation and I feel like you're getting a bigger bang for your buck in high-yield than stocks of the same companies. If earnings stay steady, prices of both high-yield bonds and stocks can recover, but if earnings decline, high-yield bond prices are likely to be less volatile than stock prices. High-yield is also attractive because more than 50% of the market is currently rated just below investment-grade and presents relatively little credit risk. Even if the economy gets worse, you can still earn close to 10% on high-yield, with much lower volatility than stocks.”
Dividend-paying value stocks from oil and product tanker companies are another potential source of income. Says Kramer, “The world is going to need more oil and there's no inventory, so we're going to need ships. Product is going to have to get delivered from one refinery to another, around the world. I think the setup for tankers is going to be very constructive over the next 2 or 3 years.”
Kramer also is finding value and income in more familiar assets such as investment-grade corporate bonds and Treasury bonds with longer maturities. ”In some cases, you can get close to 5% on some shorter-dated investment grade corporates of blue chip companies," he says.
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 Evaluator 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)
- 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.