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Income Investing Playbook for 2020

by Van Eck Global

By VanEck Global

As negative yielding government debt grows globally and U.S. interest rates remain low, where can investors look to find yield in 2020 above the levels available from savings accounts and government bonds? In this Q&A, we examine the current market environment, highlight potential areas of opportunity and discuss how they may fit within a portfolio as investors plan their 2020 allocations.

1. What trends should income investors be watching heading into 2020?

One of the most significant market events in 2019 was the surge in negative-yielding debt globally, which reached heights above $17 trillion in August.The U.S. Federal Reserve has been cutting rates, and across developed markets, we expect to see central banks continuing to ease and support slow to moderate growth.

Investors tend to fear that lower interest rates mean a global recession. However, as we forecasted at the start of 2019, China’s drip stimulus approach has been effective, and its economy has continued to grow. With China being a major contributor to the global economy, we believe it will provide sufficient support for global growth.

2. In this low-rate environment, where can investors find yield?

Many investors, concerned about the prospect of a global recession, may be shifting to a more conservative approach to fixed income, focusing on short-term and high quality income vehicles. This results in low yields and, we believe, missed opportunities. In our view, we are not headed for a global recession, and we see no reason for investors to de-risk and move away from a normal credit allocation that includes both credit risk and duration risk. In particular, we think there are opportunities in U.S. high yield and emerging markets debt, and we believe the tax-exempt status of high-yield municipal bonds continues to provide a compelling risk/reward profile.

The expanding search for yield has also led income-focused investors to look beyond traditional debt to other income producing assets, such as preferred securities, which have historically offered higher yield than a company’s common stock or senior debt. We are also seeing increasing interest in dividend investing.

3. If investors want to position their fixed income portfolio to take enough risk in the current environment, what opportunities should they explore?

In our view, there is no reason for investors to avoid either high yield or more aggressive fixed income like emerging markets bonds. In the high yield space, we believe fallen angel bonds offer many of the qualities that income investors need in a late-cycle environment, including attractive carry, higher quality and a value-oriented approach. Fallen angels are part of the overall high yield universe, but were originally issued with investment grade ratings and later downgraded to non-investment grade. The yield on fallen angels is currently in line or higher than other broad U.S. high yield indices, including those which some of the largest high yield ETFs track, so moving up in credit quality does not mean sacrificing yield.2

Emerging markets debt is another area of opportunity, in our view. Lower interest rates in developed markets, we believe, may create room for emerging markets currencies to possibly fare better versus the U.S. dollar, and for emerging markets central banks to take a more dovish stance with their own interest rate policies to support growth. Along with attractive yields and valuations, we are also seeing positive economic reforms that have the potential to fuel this asset class—such as pro-growth reforms in Brazil and corporate tax cuts in India. From a portfolio construction perspective, we believe the diversification potential of emerging markets bonds—particularly local currency bonds—is among their most attractive features.

4. How can investors add income opportunities to their fixed income portfolio without significantly adding risk?

Municipal bonds may allow investors to earn income free of federal, and potentially state, income taxes. Along with this tax preference on yield, muni bonds have historically had a very low risk of default, and muted bond issuance combined with historically strong demand has continued to drive performance. We think municipal bond ETFs that target specific maturity ranges and credit exposures can help investors find the right performance, yield and duration fit for their portfolio.

For investors looking to invest sustainably, green bonds are simply conventional bonds issued to finance environmentally friendly projects. Green bond issuance is expected to reach $200 billion this year.The rapid growth of the green bond market has provided investors the ability to segment the market and identify opportunities that match their risk and return objectives, while maintaining diversification and liquidity. For example, investors seeking to build a sustainable bond allocation without sacrificing yield or taking on currency risk may invest in an all U.S. dollar-denominated green bond portfolio. In our view, green bonds may fit seamlessly into a core bond allocation.

Investors seeking to reduce risk while maintaining an attractive yield profile may want to consider investment grade floating rate notes, which carry almost no interest rate risk. With a duration close to zero, they can be an effective way to reduce overall portfolio duration while still generating yield. Compared to short-term bonds, floating rate notes currently provide a higher yield.4

5. What are ways investors can approach equity income in the current environment?

Dividend stocks have been getting more attention lately as more investors turn to stocks for income. Typically, dividend strategies take one of two approaches: target high yield stocks or focus on companies with a consistent history of paying or increasing dividends. However, there is risk that looking solely at historical characteristics may lead investors into “dividend traps”.

Morningstar’s forward-looking approach to dividend investing looks beyond just high yielding companies to target high yielding companies that appear attractively priced and display strong financial health. Its 100-person equity research team assigns a fair value estimate to each company it covers by projecting cash flows well into the future, and Morningstar’s distance to default score reflects a firm’s probability of bankruptcy and has been an effective predictor of dividend cuts.

Preferred securities present another equity income opportunity in the current environment, serving as a complement to a portfolio’s core fixed income allocation alongside or in place of high yield debt. Historically, a company’s preferred securities have offered higher yield than its common stock or senior debt, and they have low correlations with equities and traditional fixed income instruments.

Targeting preferred securities ex-financials may provide investors with a yield premium. With financials now accounting for 70% of the U.S. preferred market, excluding traditional financial companies may result in more diverse sector exposure, reducing concentration risk without sacrificing yield.Excluding financials also increases the proportion of preferreds paying cumulative distributions and lowers the proportion of securities reaching near-term call dates.

6. What impact will central bank policy in 2020 have on markets? Any potential surprises for income investors?

A downside surprise for financial markets may come if the Fed were to make an about-face and turn hawkish. We think this is doubtful in an election year, but still worth bearing in mind. Also, we think investors should consider a hedge position in their portfolio, such as gold, in the event that European central banks lose credibility as a counterweight to slower growth.

In developed markets, we expect accommodative monetary policy to support continuing slow to moderate economic growth. We believe the lower rates are based on central banks’ willingness to be cautious about protecting growth and asset prices, rather than reflecting an impending recession. In our view, the easing in developed markets creates potential room for emerging markets central banks to also take a more dovish stance. Based on the current environment and our outlook, we think there are still many opportunities for investors to find yield and plan their 2020 allocations to meet their income needs.

Explore VanEck’s income investing ETFs.

IMPORTANT DISCLOSURE

[1] Source: Bloomberg.

[2] Source: ICE Data Services and VanEck. Data as of 9/30/2019.

[3] Source: Climate Bond Initiative.

[4] Source: FactSet. Based on the yield of MVIS US Investment Grade Floating Rate Index and the Bloomberg Barclays US Corporate 1-5 Y Index as of 9/30/2019.

[5] Source: S&P U.S. Preferred Stock Index (SPPREF). As of 10/31/19

Please note that Van Eck Securities Corporation (an affiliated broker-dealer of Van Eck Associates Corporation) offer investments products that invest in the asset classes discussed herein.

This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

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