The US-Iran conflict remains both fluid and difficult to predict. After rising tensions and fears of a weekend escalation in hostilities, markets opened on 27 July with a roughly 5% decline in Brent crude oil prices. This response came as a pause in strikes over the weekend raised hopes of both a diplomatic resolution to the war and of renewed oil and refined product flows through the Strait of Hormuz.
This may come as a relief to income investors, many of whose portfolios are dominated by bonds. CIO believes that major government bond yields will fall through the remainder of this year, as geopolitical tensions ease, oil prices moderate, and markets recalibrate their expectations around hawkish paths for central bank policy.
That said, we acknowledge that for income-seeking investors, the required assurance that they can meet their income goals sits at odds with a world of uncertain geopolitics.
So, while we keep our view on the merits of locking in elevated government bond yields and holding investment grade debt, we also believe yield investors should look for complementary, diversifying assets to strengthen their income base.
Diversified fixed income approaches. We see merit in diversified fixed income strategies for investors looking to earn higher returns from fixed income than those offered by sovereign and investment grade bonds. These approaches combine government and investment grade bonds with fixed income that is more sensitive to economic growth and corporate earnings. These types of bonds include high yield, emerging market (EM), and subordinated debt. While CIO has an Attractive rating on EM and high yield debt, the required knowledge, minimum investments, and risk management make buying single company bonds in this field a tricky task. Diversified approaches could provide investors a path to invest in a risk-controlled way, offering the potential for enhanced yield while leaving professional investors to rebalance and manage credit, interest rate, foreign exchange, and other risks.
We believe a robust fixed income allocation, which includes exposure to quality bonds as well as diversified approaches, can still provide stability and income while managing risk. Allocating between 15% and 50% of total assets to fixed income is a typical benchmark, tailored to risk tolerance, income needs, and investment horizon.
Equity income strategies. Stock investing need not be just for potential capital gains. Shares of mature companies in cash-generative sectors or industries often pay appealing dividends that can add value to income portfolios.
Swiss equities provide attractive dividend yields, many of which exceed local bond yields, and are supported by strong balance sheets and consistent profitability. Dividends have played a central role in Swiss market returns over the past three decades.
In Southeast Asia, central banks are expected to ease policy further, making dividend-focused strategies even more appealing, in our view. Southeast Asian markets feature high-quality companies with strong free cash flows and proactive capital management, resulting in consistent dividends whose payouts have historically been resilient during market volatility.
Investors should not look exclusively for the highest dividend yields. The sustainability of dividends and the quality of the companies paying them also matter.
Structured strategies. Some income investors may have the willingness and ability to look at financial tools that combine bonds and options. Of these so-called structured strategies, like reverse convertibles, may offer alternative sources of yield, the extent of which depends on the market’s perceived volatility of the underlying asset. By monetizing market volatility, reverse convertibles may deliver a unique return stream, often less correlated with traditional investments.
Systematic allocation to reverse convertibles has historically improved portfolio returns with similar risk, particularly in sideways or gently declining markets. The steady coupon payments have the potential to provide a sense of predictability, while features like barriers and autocalls can tailor risk and reward.
Reverse convertibles carry specific risks, including market, credit, liquidity, and complexity risks. Understanding these features is essential before considering an allocation.
Multi-asset income approaches. Some investors seek a single tool that spans geographies, asset classes, and regions. We believe that diversifying into income-oriented strategies, such as a multi-asset income (MAI) portfolio, could be one such approach with the potential for sustainable and recurring income streams across the business cycle.
We estimate an MAI portfolio could offer an annual income of around 5-7% per year. Such a portfolio invests dynamically across cash, bonds, equities, and volatility strategies to achieve its income target and aims to provide smooth income distributions through economic expansions and contractions.
An uncertain world need not automatically mean erratic income. While a flexible financial plan that can tolerate some fluctuation in income levels may be helpful, diversification across income-generating assets can help steady portfolios and increase reliability of funds for spending today, across one’s lifetime, and beyond.
