The first half of 2018 has not been easy going for multi-asset income investors. The MSCI World High Dividend Index has underperformed MSCI World Index by several percentage points as steady dividend paying stocks have struggled to keep up with higher growth stocks. While energy and technology stocks have raced ahead, financials, consumer staples and materials have lagged behind.
Meanwhile, higher quality bonds have slumped. For example, U.S. investment grade credit is on track for its worst calendar year of performance since the 1970s, although the riskier high yield debt sector has fared relatively better. And a volatile currencies backdrop hasn’t helped matters either, as a surprisingly strong US dollar has wrecked some havoc on emerging market foreign exchange.
So what are multi-asset income investors to do in this high risk, low-return environment?
Taking a step back and reassessing the macro outlook, although it’s moderated in the last few months, global growth is still solidly above trend and the cycle is likely to power onwards. Inflation risks are balanced, corporate earnings have been good and the removal of central bank accommodation remains very gradual, even as geopolitical anxiety and risks to global trade have ticked up. Although the late cycle will surely be accompanied by higher volatility, historically these periods have been positive for risk assets.
With this backdrop, it makes sense to stick with a pro-risk portfolio that has a preference for stocks over bonds and maintain a broad diversification across regions in equities. But to acknowledge the recent moderation of global growth and the rising risks around trade disputes, we start to inject slightly more caution into our multi asset portfolio. While we moderated the overweight to equities at the margin, our increased appetite to hold duration within portfolio can help to mitigate our risk to a good degree. The flexibility to use different asset classes to navigate complex market environment as such is a key benefit of multi asset investing.
Within equities, there is further earnings upside to U.S. stocks and they offer favorable sector exposure to technology. Emerging markets and European equities are less preferred, but they continue to provide decent dividend and diversification benefit for a multi asset income portfolio.
Meanwhile within fixed income, high yield debt is considerably more attractive than investment grade credit. With investment grade credit spreads (meaning the difference in credit yields versus risk-free government bond rates) near historical lows, the sector offers little value and carries both duration risk (meaning interest rate sensitivity) and credit risk.
More opportunistic sectors of fixed income offering greater insulation from the negative impact of rising interest rates look more compelling. For example, U.S. non-agency mortgages trade with minimal duration and provide an attractive and diversifying yield. Non-agency securities are backed by non-government guaranteed mortgage loans, meaning that detailed security selection is critical to manage credit risk. Navigated appropriately, non-agency mortgages can provide a valuable and less correlated income stream to a broader portfolio.
The second half of 2018 holds a mix of threats and opportunities. With continued higher volatility, ongoing geopolitical risks and trade tensions and rising interest rates, multi-asset income investors need to be able to seek out capital growth and sustainable income across a broad spread of asset classes and geographies.
Having a balanced approach that takes into account relative performance of asset classes across the risk-return spectrum, with the ability to be nimble and dynamic in making changes but with an unwavering focus on generating steady income, will serve multi-asset investors well in this rapidly changing environment.
Michael Schoenhaut, co-manager of JPMorgan Funds – Global Income Fund