Portfolio Chart: A menu of options as bond yields reset higher
With yields hovering close to decade highs across many fixed income sectors, investors are presented with a “menu of options”. Still, selectivity matters as recession risks loom.
The sweet spot between caution and optimism
Investment markets are off to a good start. China’s reopening, moderating US inflation and firming expectations of smaller interest rate hikes by the Federal Reserve have seemingly prompted a turn in market sentiment.
Among investors, some may be considering the prospect of dialling up risk in portfolios to make the most of the recovering market sentiment. Yet there are risks ahead. Aggressive monetary policy tightening has increased the risks of a downturn in the US, while China may be facing some challenges in the transition towards living with COVID-19. Elevated economic uncertainty may keep markets volatile for some time.
Against these considerations, investors could be searching for ways to harness opportunities in a recovering market without piling on the risks. Income investing can be one option. It presents a middle ground of opportunities that can help investors capture broader market upside while providing buffer through cash flows from income generating assets such as bonds and dividend-paying stocks to help ride through volatile times.
Dividend-paying stocks: more than just a source of income
Dividend-paying stocks have historically exhibited lower volatility versus the broader index and growth stocks. As illustrated below, the annualised volatility of the MSCI ACWI High Dividend Yield Index has consistently stayed lower than the MSCI ACWI Growth Index across different time periods.
This low volatility characteristic, coupled with meaningfully higher dividend yields relative to its growth peers, have contributed to the outperformance of dividend paying equities over the last two years. Given the uncertain economic backdrop, dividend paying equities could still play an important role for portfolios.
High dividend stocks tend to exhibit lower volatility relative to its growth peer. It has also outperformed the broader index over the last two years.
Fixed income is fashionable again
Bonds are generally the foundation of any income portfolio. After a year of significant repricing in bond markets, as illustrated below, yields across various fixed income sectors have risen to decade highs due to monetary policy tightening by major central banks. This illustrates the role of fixed income in portfolios as higher yields may bring in opportunities for higher investment income and may potentially serve as a hedge to help manage recession risks.
Stay diversified, stay flexible, stay active
Amid a fluid market environment, it is important to engage risk mindfully and prudently. Income investing can help tap investment opportunities while managing volatility via potentially steady cash flows from a diversified portfolio of income generating assets. It presents a more durable, long-term approach to revisiting market opportunities as silver linings emerge after a difficult 2022.
The flexibility to capture opportunities within and across asset classes, sectors and geographies as well as dynamically adjust portfolio allocation is essential to navigate the cross currents in an uncertain market environment. Active duration management in response to a changing interest rate environment is also critical to steer fixed income portfolios during a period of high inflation and slowing growth.