A strategy to obtain portfolio earnings throughout instances of low authorities bond yields
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Earning income through safe investments like US Treasurys was once an easy step.
Well not so much.
With returns on these government bonds close to zero, investors may need to add some risk to the income side of their portfolio.
“Twenty years ago, generating income was a one-trick pony,” said Lauren Ferry, director of portfolio strategies at Nuveen. “We could just invest in US Treasuries.
“The situation today is much more complex.”
Ferry spoke on Tuesday at the CNBC Financial Advisor Summit, a one-day virtual conference for financial advisors, on improving income in today’s environment.
The 10-year benchmark treasury yield is currently below 1%. Shorter Treasurys are also: On Thursday the one-year Treasury yield was below 0.2%.
While inflation is one of the ubiquitous risks associated with bond investing, the Federal Reserve recently stated that it is unlikely to act any time soon to stop it.
Effectively, this means that the central bank’s typical response to the specter of inflation – raising its base rate, which curbs assumed inflationary pressures – may not come as quickly as it would otherwise have. Thus, at some point, inflation could exceed the target rate of 2%.
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Ferry said at the CNBC summit that Nuveen advises clients to stay invested and diversify risk in their income portfolios.
“Not all returns are created equal,” she said.
For example, consider two asset classes: emerging market debt and senior debt (corporate debt backed by collateral). While their returns are both close to 6%, the underlying risks are different, Ferry said.
For example, emerging market debt is more sensitive to equity markets, she said. Senior loans, on the other hand, are more sensitive to credit risk (ie, the risk of default).
“Knowing what is driving these asset classes, whether it is interest rates, credit or equity markets, and then having a forward-looking view of those drivers, helps us build diversification [income] Portfolios, “said Ferry.
She also advises against holding cash. With interest rates as low as compared to inflation, this means that the longer your money sits there the longer it loses purchasing power.
“Think about real returns … we are in negative territory when you factor in inflation,” Ferry said. “It’s like filling your canteen with water before a long hike. Then you reach your destination and realize that you had a leak the whole time.
“That’s the effect of inflation,” she said.
You can also consider adding alternatives to your portfolio to diversify your risk and revenue streams. For example, personal loans (debts of private companies to publicly traded companies) could complement your core bond investments, according to Ferry.
“But there is a compromise … it could lead to more illiquidity,” she said. “You can probably give up a little liquidity for that extra return premium.”