Alternatives / Multi-Asset

Looking for Income in All the Right Places

By Morgan Harting, Martin Atkin June 29, 2015
Looking for Income in All the Right Places

Investors and advisors know they can’t depend solely on the old standbys—bonds, high-dividend stocks and cash—to produce income today, and they’re ready to try a new approach. But which one?

Answering that question isn’t easy. Sure, 70% of the 2000 respondents in our Global Income Survey said they thought they’d have to change their investment portfolio over the next year or two to meet their income needs (Display).

But very few of the people we surveyed said they were comfortable with simply replacing the traditional income-generators with higher-yielding variants of the old standbys. While that approach might boost income, it can also expose investors to unwanted concentration and downside risks.

Instead, we found that when it comes to income, stability is as valuable as amount. So what’s an investor to do? We think dynamic global multi-asset strategies can help by offering a promising one-stop solution for those looking for high and steady income and the possibility of capital growth.

A multi-asset approach widens the opportunity set for investors by mixing tactical allocations to a vast array of assets, including commodities, real estate, emerging markets and other less traditional investments, to the usual mix of stocks and bonds. And because it’s managed dynamically, it can capture opportunities as they arise and adjust risk exposure as market conditions evolve.

This clearly resonated with survey participants. Majorities of all three of our target groups—retail investors, financial advisors and brokerage firm gatekeepers who help evaluate and select asset managers—said they were open to a multi-asset class solution.

The Right Recipe

Of course, finding the right mix of assets is critical. A simplistic fusion of high-yield bonds and high-dividend stocks, for instance, may generate high income but would also have a high correlation to global equity markets. A broad equity market decline would likely hit such a portfolio hard.

In our view, an effective multi-asset approach requires greater diversification and dynamic risk management. That requires drawing on the broadest possible universe of assets and strategies and paying close attention to asset correlations.

For instance, some assets tend to generate high levels of income (high-yield bonds, mortgage-backed securities) or have the potential to build income over time (high-dividend stocks, real estate investment trusts).

But the former—call them the “income producers”—carry credit risk and are sensitive to the ebb and flow of the economic cycle. The “income growers,” meanwhile, are even more volatile and highly sensitive to broad market moves.

The Key Ingredient: Income Diversifiers

The most effective multi-asset income strategies, in our view, stir some diversifying assets or strategies into the mix—ideally with little sensitivity to the broader stock market and the ability to help insulate a portfolio from downside risk.

These added ingredients—let’s call them “income diversifiers”—can include government bonds, equity options and “long-short” strategies that take advantage of yield differentials in currency and bond markets.

Beware the Bolt-On Approach

Simply bolting these three components together isn’t enough, though. This is where dynamic management comes in. It’s still important to monitor a multi-asset portfolio and be ready to tinker with the asset mix as the environment changes.

In normal market conditions, for example, most of a portfolio’s exposure might be to income producers and income growers. A broad rise in market volatility, however, might call for more exposure to income diversifiers.

As conditions change, managers must be able to adjust exposures quickly. This requires monitoring the risk, return and correlation of each asset class on a daily basis.

By embracing a multi-asset strategy, investors and advisors who may not agree on individual income-generators can get globally diversified exposure to all of them. And a less-constrained solution that avoids unintended risks can help generate income that’s not only high, but stable, too.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Looking for Income in All the Right Places
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