Market Views: Income ideas in a high-rate environment
With the highest interest rate environment in many years to battle inflation, income-generating assets are back in favour with investors.
The fact that investors are hunting for income is also evident from what fund selectors have told AsianInvestor recently.
When interest rates are high, some ultra-cautious investors may rely on cash deposits to generate income. However, there is no guarantee that interest gains can outrun inflation.
The answer is to capture both dividends and bond yields, typically considered a strong strategy to generate income. Still, investors still need to strike a balance between income and capital appreciation.
The investment-grade fixed income sector is considered noteworthy in this regard, “as clients are looking to capitalise on the current attractive yield offered by high-quality credits and preparing to capture potential capital gains from anticipated rate cuts in the future,” Joffrey Desrousseaux, head of investment solutions at DBS Private Bank, told AsianInvestor in October. He leads the fund selection team in Hong Kong.
Another fund selector, Gareth Nicholson, chief investment officer and head of discretionary portfolio management of international wealth management at Nomura, also noted that the main interest from clients is income.
With high demand for income, AsianInvestor asked asset managers where they see the biggest income-generating opportunities across asset classes over the next six months.
The following responses have been edited for clarity and brevity.
Ecaterina Bigos, chief investment officer, core investments, Asia ex-Japan
AXA Investment Managers
The relentless rise in bond yields on the back of tightening in global monetary conditions, over the last and this year, means that carry from bonds hasn’t been this attractive in over a decade.
Higher inflation erodes bond returns.
As inflation has been decelerating, the final stages of disinflation could prove more difficult, primarily due to tight labour markets.
Hence rates are expected to stay higher for longer.
Two-way volatility is expected, on potential inflation surprises and higher fiscal deficits.
It would however take a substantial surprise in the inflation print relative to current central bank expectations to deliver another hike.
With regards to spreads, those have been meaningfully tighter during quantitative easing and have been much wider in periods of credit stress in particular sectors.
Notably, fixed income all in yields is undeniably attractive, relative to history and relative to equity.
Far fewer stocks are now offering a yield spread relative to credit.
Relative to cash, which arguably has similar yields relative to some higher quality bonds - bonds are expected to outperform on yield and total return basis.
Once the rate cycle turns, cash rates will only go down from there.
Clive Maguchu, senior strategist
State Street Global Advisors
Global growth is set to slow meaningfully into 2024.
However, central banks may not pre-emptively cut rates with inflation remaining sticky and still-tight labour markets, so there is the potential for rates to still move higher relative to current level and remain higher for longer.
This environment creates income generating opportunities in several asset classes.
Cash and money market securities offer an attractive risk/reward trade-off due to their floating rate nature and their lower duration compared to traditional fixed interest segment.
This strategy is great in the short term until rates start to go lower.
Even if we still expect more upside potential for yields, we now see now more value in bonds which would lock in coupons and eliminate reinvestment risk.
The primary cyclical trends investors should expect over the next six to 12 months are lower rates, steeper curves, and wider spreads.
We have a cautious stance towards credit, owning higher quality, lower beta instruments, and a preference for investment grade over high yield.
We recommend a cautious stance towards equities and favour a quality defensive approach in the present climate.
Regionally, we prefer US large caps because of their higher exposure to the quality factor and strong balance sheets.
Marcella Chow, global market strategist
J.P. Morgan Asset Management
With the US growth resiliency expected to dial back slightly and Asian tech cycle likely to have bottomed, US-Asia growth differential is likely to move in favour of Asia equities next year.
High dividend stocks have been outperforming in recent months, and we continue to see opportunities there.
Asia corporates are supported by robust balance sheets and lower debt levels relative to their historical average, which bodes well for dividends in addition to providing shelter from deteriorating economic conditions.
Valuations are also relatively compressed compared to developed markets.
Moreover, from a macro perspective, a recovery in the export and semiconductor cycle and further stabilisation in China’s economic momentum may be supportive of Asian equity earnings and dividends.
Asian economies are also likely to enjoy a healthy growth differential relative to the US in 2024, and the region’s monetary policy continues to be supportive on a comparative basis.
Given the macroeconomic uncertainties and the likely decline in cash rates over the next six to 12 months, it will be increasingly essential to find the complementary pairing of fundamental resilience and stable dividends to preserve and enhance the total return of a portfolio.
David Chao, global market strategist, Asia Pacific ex-Japan
Invesco
Even though long duration US government bonds and US dollar cash deposits are generating healthy yields, investors may consider other fixed income assets that could add diversity and potentially higher returns to a neutral asset allocation portfolio - emerging market government bonds, US bank loans and private credit.
The recent rise in interest rates have propelled bank loans yields.
The bank loans asset class has a cyclical element due to the risk of defaults – high current yields offer sufficient compensation for the default risk.
We favour emerging market soft currency government bonds with generous yields, and the US dollar is likely to depreciate next year with cuts to the Fed’s policy rate around the middle of the year.
Indian government bonds look attractive and have recently been included in a major emerging market bond index.
Alternative investments such as private credit are also appealing in a high interest rate environment.
Over the course of the last 18 months, interest rates have trudged upwards and today, the unlevered yields for direct lending asset class generally range from 12-13%.
Markets could be entering a period of consolidation among cyclical assets and higher for longer interest rates could pressure equities.
Cash rates are higher than normal, and we are overweight cash at a 10% maximum allocation.
Geoffrey Lunt, head of Asia investment specialists
HSBC Asset Management
You must go back to the financial crisis of 2008/09, essentially a credit crisis, to find higher yields on investment grade US corporate bonds.
At around 6.5%, investors are being offered a tempting entry point which - in historical terms at least - may only be available once or twice in a generation.
US high yield, offering close to 9.5%, is also yielding 300 basis points above its long term average, although has had more crisis induced spikes above current levels in recent years.
This makes us feel that, even plain “vanilla”, bonds, offer investors a skew of outcomes which is in their favour.
This doesn’t mean we are very negative on equities, but with economic uncertainties and pockets of expensive valuation, a high weighting to fixed income seems a prudent approach, especially if income is a priority.
Meanwhile, we would continue to advocate a granular approach to market allocation.
Some emerging markets, for instance India, offer the opportunity of capital gain potential from an equity market enjoying significant growth and development tailwinds, together with a bond market where even the sovereign is yielding well over 7%.
Dongyue Zhang, head of multi-asset investment solutions specialists
abrdn
With the potential of central banks cutting interest rates in 2024 to cope with a slowdown in global economy, we believe investors need to look for alternative sources of income-generating assets.
Stock market listings – be it a REIT, investment trust or other corporate structure – is a great way to access a range of non-traditional investment opportunities.
Many listed alternative assets are legally required to distribute a substantial amount of income, typically more than 80-90%, via dividends to shareholders.
The low influence from general economic ups and downs means they are better placed to deliver resilient income of over 5%.
The revenues of listed alternatives are often linked to inflation, either directly through government subsidies, such as for renewable and social infrastructure, or indirectly.
Typically listed alternatives offer higher risk-adjusted return potential to equities and bonds.
Generally, they have been, and are expected to remain, less volatile and provide higher returns. Further, these assets are listed on the exchange – so investors can buy and sell them daily, with no capital lock-up.
Ben Kirby, co-head of investments
Thornburg Investment Management
A regime change is taking place on the investing scene, which presents investors an opportunity to recalibrate their portfolios to profit from current conditions.
The end of near-zero interest rates represents a return to a more normal environment.
These higher rates mean that investors should shift their focus to companies that can generate cash flows and pay dividends, which have played a substantial role in the total return profile of equities over the long term.
Historically, dividend-paying companies have outperformed the market over time, and companies with track records of growing their dividends have done even better while offering lower volatility.
Investors can find much better equity income ideas outside of the US where valuations are lower.
We think this current environment creates some exciting opportunities for active management.
Smart investors are positioned for long-term growth in their portfolios and avoiding the complacency of investing too much cash in money markets or buying the S&P 500 index and hiding out.
Seth Meyer, head of fixed income strategy
Janus Henderson Investors
We believe income-seeking investors in the current climate should seriously consider areas of securitised fixed income for their stable and relatively high yielding qualities in the coming six months and beyond.
The market currently has priced in about four rate cuts even as the Fed’s indicated two further cuts, perhaps one in the middle of the year and the other post-election.
Based on current economic data, we believe there’s a possibility of just one or perhaps even zero cuts.
This means investors are at the short end of the yield curve and likely going to continue to enjoy a high rate of interest, carry and yield.
This greatly benefits investors because the most discerning of them can avoid interest rate risk while getting income and yield.
For example, AAA-rated collateralised loan obligations (CLOs), which puts corporate loans into securitisation, went from a couple percent of yield to about 6.5% today as a function of interest rate hikes.
That’s a very powerful feature in a rising interest rate environment, which will carry beyond the coming six months.