Many investors need income, but not at any cost. So, how can investors generate a stable income in an uncertain world where even the ‘safest’ bond markets are experiencing volatility spikes?
Exploiting an unconstrained landscape, applying a flexible and knowledgeable mindset, and maximising diversification could be the key to creating resilient income-generating portfolios.
Rising need for income
Investing for income is a common strategy used by investors hoping to achieve a higher return than they can achieve through cash in order to provide a regular income stream or as a supplement to other income sources.
Income investment strategies are particularly useful for those in retirement. Changing dynamics in terms of demographics and the global pension market could lead to a greater number of investors looking for regular, stable income streams.
In particular, increased longevity and falling birth rates are leading to ageing populations in many countries, which could create funding challenges for governments. The old age dependency ratio – which compares the number of over 65s within the working age population – is moving in the wrong direction and is expected to reach 50% in at least 20 countries by 2050, which means there is just one worker per retiree1. Such a change could force many nations to increase the age qualification for state pensions, placing a greater onus on retirees to generate their own income.
However, the search for income is not straightforward. Many investors venture into equities or riskier parts of the bond market, thereby taking on greater levels of risk in this pursuit.
A less certain world
Fixed income has traditionally been a haven for income-seeking investors – even its name denotes stable income. However, since the turn of the 21st century, the fixed income landscape has evolved considerably. Initially, rates moved structurally lower; the aftermath of the Global Financial Crisis then resulted in an extended period of negative interest rates. More recently, the 2020s have seen a pandemic and an inflation spike create volatility across fixed income markets. And right now, the aggressive economic agenda of the Trump administration is increasing uncertainty and generating fresh volatility, particularly for US Treasuries.
Such volatility creates dispersion across the different geographies and segments making up the vast fixed income universe. And dispersion can create a really rich opportunity set, which can help enhance returns for income investors without necessarily dialling up risk.
Diversifying fixed income risk
When uncertainty is high, it is even more important to find ways to build resilience and return consistency into portfolios. Rather than simply “chasing yield” or attempting to time the market, a nimble and diversified approach to fixed income can yield positive outcomes without raising risk or significantly lowering expected returns.
In fact, when uncertainty prevails, investors should look beyond traditional bond safe havens. The global fixed income universe offers more scope for diversification and risk management options, providing enough shelter to weather any storms. By applying an expert eye across the different facets of the global fixed income landscape, including government, investment grade, high yield and emerging market bonds, as well as structured securities, it is possible to find assets that offer adequate returns for the level of risk involved.
Today, government bond yields in the US and Europe are at multi-year highs, enabling investors to realise compelling income. Investment-grade corporate bonds are also attractive, although their generally tight spreads (yield over equivalent duration government yields) make them more sensitive to changes in sovereign bond rates. The high-yield (sub-investment-grade) corporate and emerging markets sectors offer higher yields, which can provide more of a cushion against volatility, but they are typically more sensitive to the ebbs and flows of investor sentiment and geopolitical risk.Meanwhile, exposure to fixed-income asset classes like Treasury Inflation-Protected Securities can offer protection against rising inflation; structured products, such as asset-backed securities, can diversify corporate bond exposure; and floating-rate securities, including collateralised loans, can help diminish the impact of interest rate volatility.
By diversifying across a variety of asset types and regions, a global fixed income strategy can provide a predictable income while maintaining moderate levels of risk and preserving capital over the long term.
An unconstrained approach
To fully take advantage of the vast fixed income opportunity set, an income strategy needs to be agile enough to move quickly and seamlessly across sectors, geographies and structures.
A dynamic approach should have the flexibility to invest across a wide range of fixed income securities without being tied to a specific benchmark. Applying a go anywhere approach helps avoid structural biases to particular geographies or asset types, providing the freedom to invest in the best ideas at any time while avoiding areas that don’t offer good value. Yet, a genuinely benchmark-agnostic approach also requires portfolio discipline and specialist insights to ensure capital is only invested into assets, markets and securities where the return offered compensates for the level of risks involved.By fully accounting for these risks in the construction process, it is possible to build a portfolio that’s capable of performing across a much wider range of economic scenarios than simply just a base case.
In an uncertain and volatile world, a global income strategy should demonstrate both flexibility and resilience so that it can smooth out income streams and manage risk.
Rethinking income investing
Against a less certain and more volatile investment backdrop, it may be time to rethink your income approach by shifting away from traditional income strategies and embracing greater diversification and flexibility.
At BNP Paribas Asset Management, our Global Income strategy takes a dynamic and multi-sector approach towards income generation. By collaborating with specialists across our fixed income platform, we aim to find a diversified range of the best global fixed income ideas so that we can deliver a high and predictable income throughout the market cycle with investment-grade stability.
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