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October 2017

Pursuing income across asset classes

Structural factors – ageing populations, poor productivity growth – are holding down bond yields, making the search for yield an ongoing challenge.

Investors may consider options across equity, fixed income, and multi-asset ETFs to seek attractive sources of income.

An upbeat stretch of above-trend global economic growth has not altered what’s an environment of historically low bond yields. Structural factors – ageing populations, poor productivity growth, constant demand for safe assets – are playing a role in holding down benchmark yields. We believe investors may pursue attractive yields across asset classes and see income opportunities in some of the following exchange traded fund (ETF) exposures:

  1. Equity strategies that contain certain high dividend and growth strategies, unique underlying functionality or depressed prices that may provide high yielding opportunities.
  2. Fixed income exposures in high yield corporate bonds (HY), emerging market debt, longer duration products or mortgage backed securities (MBS).
  3. Multi asset strategies with high yield potential across asset classes.

Income in a traditional 60 / 40 portfolio has changed meaningfully

Income in a traditional 60 / 40 portfolio has changed meaningfully

Source: BlackRock Investment Institute, Thomson Reuters as of 9/26/2017.

Notes: Index performance is for illustrative purposes only. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Equity

High yield exposures from equities come in different forms. First, a business model can create high yields. Mortgage REITs use leverage to purchase existing mortgages in an effort to maximize their net interest margin, in turn paying out dividends. This makes them typically among the highest yielding equities. Yet such a business model makes them increasingly susceptible to changes in borrowing costs. Another example: preferred stock, which has characteristics of bonds (pays a fixed dividend) and stocks (represents an ownership in a company), has historically had an attractive yield.

Second, high dividend strategies across the globe can provide competitive yields. Whether looking at different regions from developed markets (DM) to emerging markets (EM), high dividend strategies have offered investors yields that can be more compelling than traditional income assets. Although these exposures may suffer equity-like volatility and be sensitive to swings in interest rates, their returns can diversify portfolio income.

Fixed income

Select high yield, longer duration and EM strategies may also produce heftier yields. In the EM fixed income space, both dollar and local currency indexes currently yield over 4%. Not only is this relatively high yield attractive, but the improving credit quality in many emerging market economies can give investors added confidence. The weighting of investment grade has increased to roughly 50% today from 15% in 1997.1 Further improvements in trade and capital balances, after a major shake-out in 2013-16, may help reduce the sensitivity of EM income to swings in DM bond yields.

High yield is also a source of income, with U.S. benchmarks currently yielding roughly 5%. One concern is that spreads are near their tightest levels in years and volatility could be prone to mean revert, just as asset volatility has showed some signs of stirring.2 But the high yield market can benefit from the backdrop of a sustained global expansion and robust corporate earnings growth around the world.

Multi asset

A more diversified approach to pursuing yield may include multi asset exposures. Some of these strategies invest in equities, fixed income and other income sources to balance interest rate sensitivity through the capital structure. This cross-asset balancing act can deliver high income as well as capital appreciation.

Conclusion

Longer term factors could limit the income from traditional bond exposures. We believe opportunities for yield still exist in less traditional exposures through fixed income, equities and in the multi asset space. The investment risks vary and require an understanding of their idiosyncrasies, yet investors may find attractive ways to complement and diversify portfolio income.

High yielding equity, fixed income, and multi asset indexes

High yielding equity, fixed income, and multi asset indexes

Source: Thomson Reuters, BlackRock, as of September 29th, 2017.

Notes: Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index returns do not represent actual iShares Fund performance, which may be obtained by visiting www.iShares.com. Mortgage REITs represented by the FTSE NAREIT All Mortgage Capped index, U.S. high yield by the iBoxx $ High Yield Corporate Bond index, U.S. preferred stocks by the S&P Preferred Stock Index, Emerging markets ($) by the JP Morgan USD Emerging Market Bond Index (EMBI), Emerging market dividend by the Dow Jones Emerging Markets Select Dividend Index, Russian equities by the MSCI Russia Index, Multi asset income by the Morningstar Multi-Asset High Income Index, Asia Pacific dividend by the Dow Jones Asia Pacific Select Dividend 30 Index, U.S. high yield (interest rate hedged) by the iBoxx USD Liquid High Yield Interest Rate Hedged Index, Emerging markets (local) by the JP Morgan Local Emerging Market Bond Index, U.S. credit 10yr+ by the Bloomberg Barclays U.S. Universal 10+ Year Index. International select dividend by the Dow Jones EPAC Select Dividend index, MBS by the Bloomberg Barclays US Mortgage Backed Securities Index.