With the S&P 500 hitting record highs, it’s easy to lose sight of the much larger universe of investment opportunities that exists beyond those 500 US-listed stocks. But while it’s true that stocks have been the best-performing asset class in 10 of the last 15 years, in 15 of the past 25 years, some of those other investments have outperformed stocks, even in years when stocks have returned close to their historical average of almost 10%.
That’s something to keep in mind as the second quarter of 2024 begins. It’s impossible to know how much longer stocks will continue to outperform other investments, so it may be a good time to learn more about those other relatively high-yielding opportunities. Indeed, because many investors’ attentions are focused on stocks, some of these investments may be available at reasonable prices and they are also paying attractive interest rates—or coupons.
Adam Kramer manages Fidelity® Multi-Asset Income Fund (FMSDX) and he seeks opportunities in a wide variety of assets, caused by temporary mispricing of assets as investors overreact to fear or uncertainty. “In a good environment for stocks, there are still a lot of other opportunities out there,” he says. “In fact, if you have the skill and research capabilities to find these opportunities, it’s possible to get total returns that are close to the historical average returns of stocks, but with much less downside risk.”
Kramer says that one reason why opportunities are appearing now is that uncertainty about where the economy is headed is causing genuine differences of opinion among investors about how to value assets in the marketplace. “The US economy is in the longest late phase of the business cycle since 1950, but market sentiment is more mid-cycle,” says Kramer. “We're seeing some mid-cycle sentiment priced into some of the asset classes, while other asset classes are pricing in a recession. That’s where the opportunity is, if you can find those mispricings, while avoiding things that are pricing in mid-cycle conditions, unless they offer really great coupon yields.”
Finding opportunities in US Treasury bonds
Kramer says that US Treasury bonds with short- to medium-term maturities can be a good place to get attractive income with low risk and the potential for capital appreciation when interest rates move lower. Since the Federal Reserve began raising interest rates in 2022, rising yields have been accompanied by falling prices for Treasury bonds that were already in the market. Because bond yields and prices move in opposite directions, the increasing likelihood that yields and interest rates will move lower could provide an opportunity for Treasury prices to rise.
"These short and medium-maturity Treasurys are offering a very rare opportunity to 'do more with less,'" he says. "These bonds' relatively high coupon payments may offset the risk to prices that interest rates could stay higher for longer. That means they should also offer downside protection and could potentially generate significant single-digit total returns if rates move lower." For example, as of March 28, 2024, 7-year Treasurys are offering a 4.3% current yield. If the Federal Reserve cuts interest rates by 100 basis points in the coming months, you would earn your 4.3% coupon plus capital appreciation of 6%. That would mean your potential upside total return would be 10.3% when the Fed makes its first rate cut. If rates were to instead rise by 100 basis points, you would lose that 6% increase in principal, but the 4.3% coupon would limit the decline in the total return of your investment to only 1.7%, assuming you hold onto it for the entire 12 months. Says Kramer: "If you want the yield, liquidity, and low default risk of Treasurys plus the potential for rising prices when rates fall, this may be a good time to get those things at attractive prices."
Opportunities beyond Treasurys
While Treasurys may present a unique opportunity as the second quarter of 2024 begins, Kramer also says a wide variety of income assets may deliver stock-like returns with less potential volatility than stocks. That's especially a consideration if the economy does in fact slow down from its current late-cycle state. Stocks have historically outperformed both bonds and cash but during recessions, both bonds and cash have performed better than stocks.
Opportunities to do more with less are not secrets, but not all investment managers focus their attention on finding them. "Every manager's looking at stocks and investment-grade bonds," says Kramer. "Not as many are doing the work on other securities, but if we do the research, we can find opportunities."
One opportunity may exist in fixed-to-floating preferred stocks. Despite their name, preferred stocks are actually hybrid securities that in some ways resemble bonds but also represent equity shares in the companies that issue them.
Kramer likes preferred stocks of investment-grade US utility companies, master limited partnerships (MLPs), and big US banks, particularly those whose interest rates are either rising now or are scheduled to do so in 2024. "I think that those may be great ways to earn high, single-digit yields now while you wait for their prices to rise. Right now, you can buy them for less than their face value and their issuers can choose to buy them back from you for face value. If they don't choose to do that, the interest rates that they pay may increase and you could earn a higher return that way. If you're looking for income, you'd probably rather collect an 8% or 9% current yield on these fixed-to-floating preferreds than a 3% dividend yield from the stocks of these same companies."
Opportunities in short-maturity, high-yield corporate bonds
Another group of income-producing assets likely to offer attractive returns in 2024 are bonds issued by companies whose credit ratings are just below investment grade.
Kramer says that the short-maturity, high-yield bonds issued by these companies can provide an attractive alternative to owning those companies’ stocks, especially in a recession. In past recessions, bond prices have historically risen while stock prices have fallen. Right now, the coupons on many high-yield bonds are also higher than they have been in recent years. Those coupon payments, as well as their prices in the marketplace, contribute to the total return of these bonds.
Kramer says the default risk of companies rated just below investment grade has historically been low and he explains, "I feel like you're getting a bigger bang for your buck in high-yield bonds than in stocks of the same companies. 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. That's unusual. So even if the economy gets worse, you could still earn close to 10% on high yield with typically much less volatility than stocks." In a diversified portfolio, those high yields could potentially offset declines in asset prices that often accompany economic slowdowns.Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions. Credit quality also varies widely among high-yield bonds, so careful research is important.
Opportunities in loans and MLPs
Kramer has also found opportunities in floating-rate loans that banks make to companies and then sell to investors. Credit quality is an important consideration for investors in loans and Kramer is focusing on loans to what he believes are high-quality companies. ”If you’re getting a 9% current yield on a loan to a company such as Uber or Four Seasons Hotels or Bass Pro Shops, it matters less what's going to happen with the short-term market prices of these securities," says Kramer.
Securities issued by master limited partnerships (MLPs) that own and operate oil and natural gas pipelines are another place where one can currently find 8% to 9% yields. "In the past, master limited partnerships were shunned because everybody was down on energy pipelines and production, but we do need oil and gas," says Kramer. "These companies have been reducing their capital spending and acquisitions and their free cash flow yield is expanding as a result. This is a situation where the payout ratios have been dropping into the 50s, which is quite attractive for something that can have around a 9% dividend yield."
Finding—and using—ideas
Professional management and research can help you manage the risks that come from venturing into less-common income investments. 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.