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Thought of the day

Federal Reserve officials begin their two-day policy meeting on Tuesday, while their counterparts at the European Central Bank and the Bank of England will meet later this week. No changes to policy rates are expected, but investors will be watching for signals on how the Iran war and elevated energy prices could shape the path for interest rates.

With talks between the US and Iran stalling and the Strait of Hormuz still closed, fears of higher-for-longer oil prices and more hawkish central banks have kept government bond yields in USD, EUR, and GBP well above pre-conflict levels.

But we think markets have overpriced the risk that central banks will hike, or not cut, interest rates. Policymakers typically look through supply shocks such as oil spikes, and if oil prices remain high, yields should also fall over the medium term as recession risks rise and rate cuts come back into focus. We see current yields as attractive for investors looking to diversify their portfolios and boost income.

Attractive yields offer an opportunity to add to quality bonds. The recent increase in benchmark government bond yields provides a compelling entry point, in our view. After years of strong equity performance relative to bonds, many investors can rebalance toward fixed income, bringing allocations back in line with long-term plans. This is critical especially when stocks are at all-time highs and equity valuations have increased. We favor quality government bonds with short to medium maturities, as they not only offer appealing yields, but they also can potentially help stabilize portfolios during periods of uncertainty. Even in countries like Switzerland, where government debt yields remain low and inflation is muted, some allocation to government bonds makes sense for adverse economic scenarios.

A diversified fixed income exposure can provide additional sources of yield. A well-diversified fixed income portfolio can include some exposure to more growth-sensitive credit segments such as emerging markets, high yield, or subordinated debt, in our view. In the context of a diversified portfolio, riskier credit can help improve overall returns. But we also think it’s important to avoid overexposure to any single segment, and that investors should balance income generation with risk management. Tools to achieve these aims include diversified fixed income vehicles or building block approaches that provide access to managed portfolios of single bonds.

Select stock markets and equity structures are an alternative to income generation. For investors in countries where bond yields are subdued or credit spreads are tight, equity income strategies may offer compelling alternatives. We favor Switzerland and Southeast Asia, where quality dividend stocks offer attractive yields. To further enhance yields and diversify returns, investors can combine dividend strategies with systematic option-selling. This may provide a more resilient income stream across market cycles, enabling investors to boost portfolio income without taking on excessive risk. Additionally, investors may consider reverse convertibles to generate yield in parts of the equity market where implied volatility remains above average. It is important that investors understand the unique features and characteristics of structured strategies before investing, especially how they fit as part of a well-diversified portfolio and a wider financial plan.

So, while we maintain our positive outlook on global equities, we see a number of strategies investors can consider for enhancing their portfolio income and resilience amid an uncertain market environment.