Hunt for yield

With interest rates set to stay low, investors should look for opportunities to improve their yield.

At a glance

Against a backdrop of lower-for-longer rates, investors are being pushed harder to find yield. However, while credit spreads have tightened, we still see value in credit as a means of income generation. We like US investment grade and high yield bonds, USD-denominated emerging market sovereign bonds, European crossover bonds, green bonds, and Asia high yield bonds. We also highlight opportunities in high-dividend paying stocks.

Risks assets have rallied as the COVID-19 pandemic is brought under control.

Monetary policy looks set to remain accommodative, keeping rates lower rates for longer. In July, top Federal Reserve officials continued to stress that rates would remain near zero for the foreseeable future, indicating that the central bank would be willing to allow inflation to overshoot the 2% target for some time before rates needed to rise. Meanwhile, the European Central Bank has expanded its emergency bond-buying program.

Against the backdrop of central bank buying and this low-rate environment, the search for yield is back on. We highlight a number of opportunities where investors can add yield to their portfolios:

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US high yield credit. Credit has performed well since the Fed started start buying assets. Bond spreads relative to the risk-free rate were at their widest on 23 March, standing at 1,084 basis points. Since then, they have tightened significantly. We see potential for further total returns of around 5% in our central scenario over the coming 12 months, and even higher in our upside scenario.  Additionally in high yield, we see opportunities in the riskier spectrum for risk-tolerant investors, which added to diversified portfolios may add return prospects.

Emerging market US dollar-denominated sovereign bonds. The J.P. Morgan EMBI Global Diversified Index, the leading benchmark for emerging market sovereign bonds denominated in US dollars, holds true to its name: It hosts over 70 issuers and hence is well protected against idiosyncratic risks. Our central scenario targets imply a roughly around 10% total return on these bonds over the coming 12 months. Additionally in EM, we also see a number of opportunities in the riskier spectrum for risk-tolerant investors, which added to diversified portfolios may add return prospects.

Asian high yield credit. Spreads remain historically elevated. We expect them to tighten further as economies globally continue to gradually re-open and the rally broadens to lower-rated, more cyclical segments. Default rates of around 4–5% this year have likely been priced in, and the core of the index exposure is to China (nearly 60% weighting), where we hold a more stable view, particularly on the Chinese property sector. We see total returns of around 10% over the next year in our central scenario.

Green bonds. We see particular opportunities in green bonds, which we believe will exhibit lower volatility and smaller drawdowns compared to non-green bonds during periods of market stress, given their more conservative sector and credit profile.

US investment grade. Valuations remain relatively attractive and policy from both monetary and fiscal authorities is supportive.

Asian investment grade credit. In Asia, we prefer BBB within investment grade. We favor bonds that can provide enough spread cushion to withstand the volatility in rates, including bonds of Chinese government-related issuers and select corporate bonds issued by privately owned Indian companies.

Eurozone crossover bonds. In Europe, we look for select investments in the “crossover zone” between investment grade and high yield. The ECB is buying bonds, so corporate spreads should be relatively contained, and investors willing and able to stomach the potential volatility of “crossover credit” investments can earn potentially significant alpha if key rating agency action is anticipated correctly.

Dividend-paying equities. Dividend payments, which are an important part of shareholder returns, are still attractive at current levels, particularly compared to government bond yields. While we expect dividend cuts as a result of COVID-19 (more so in Europe than the US), history has shown that dividend-paying stocks tend to have defensive characteristics. We recommend using a selective approach that identifies companies with attractive, relatively high dividends that we expect to be sustainable.

Key investment takeaways:

  • Central banks have reaffirmed their commitment to keep policy accommodative.
  • The result is that rates should stay lower for the foreseeable future, meaning investors will likely be pushed to search harder for yield.
  • We highlight opportunities across credit as well as high-dividend paying stocks.

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