Alternative Income Strategies for a Challenging Market Environment

As we are considering updating the allocation mixes of the traditional equity and bond portfolio to cope with the current market environment, investors could consider alternative investment strategies that could help better diversify risk and maintain yields for changing conditions.

In the recent webcast, How to make your fixed income allocation sustainableMatthew Bartolini, head of SPDR® Americas research at State Street Global Advisors, pointed out that while retail investors have maintained a significant overweight in equities, hedge funds and risk-controlled exposures may have reduced their allocations to equities.

Meanwhile, on the fixed income side, with inflation proving to be less transient than initially thought, interest in Inflation-Protected Treasury ETFs (TIPS) continues to rise. accelerate. Bartolini noted that most bond segments have been in loss since the start of the year, creating opportunities to harvest tax losses in a year of strong equity performance. Given the Fed’s rate hike expectations and tighter monetary policy in 2022, two-year yields saw their largest month-on-month rise since February 2020. Despite rising inflation expectations, Yield spreads at 10 and short-term rates were the main driver.

In addition, the credit spread of the lowest rated high yield bonds tightened further in October, but remains above its lowest level of the year. Investment grade bonds outperformed last month, but have lagged significantly high yield bonds since the start of the year, given the duration headwinds, Bartolini added.

Looking ahead, Bartolini noted that futures contracts predict two rate hikes for next year, with short- and medium-term inflation expectations seeing their biggest monthly increases in more than a year.

With rates still well below historical levels, income generation remains a challenge for bond investors. Bartolini argued that the credit sectors, while expensive, can be a source. For example, high yield loans, senior loans and senior loans still offer attractive yield opportunities.

Scott Ladner, CIO of Horizon Investments, argued that while exposures to traditional fixed income assets have helped investors generate higher returns through capital appreciation and returns, these good times will not last forever. . Even in recent years, total yields have slowed down.

Therefore, Ladner warned that the traditional 60% equity and 40% bond portfolio would have to adjust over time, causing a more aggressive 80/20 split with the inclusion of alternatives to strengthen the portion of income.

Ladner believes that using hedged equity strategies is a way to produce the look of a traditional 60/40 portfolio without wasting the portfolio allocation on potentially “dead” fixed income money. Another possibility is the dynamic use of non-traditional FI categories like converts, loans and favorites. However, Ladner noted that these alternatives must also be managed by risk due to their riskier nature compared to a public debt portfolio.

Komson Silapachai, research and portfolio strategy partner at Sage Advisory, also pointed out that inflation is a key theme that many bond investors are paying attention to as rising inflation eats away at real yields and erodes the market. purchasing power of the dollar. .

However, rising inflation is not always a bad thing. Silapachai noted that positive inflation expectations lead to increased aggregate demand, wages and growth. Positive inflation gives the Fed the ability to deal with downturns. The problem only occurs when we experience hyperinflation where the private sector is unable to plan its spending and spend resources to fight inflation.

Silapachai also highlighted a number of off-the-beaten-path fixed income strategies to help investors improve yield generation and generate higher returns in this challenging market, including TIP, Mortgages, Business, high yield bonds, emerging market debt securities, senior loans, leveraged loans and alternative sources of return.

Financial advisors who want to learn more about fixed income strategies can watch the webcast here on demand.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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