LOW YIELDS and skinny corporate bond coupons are not the makings of a traditional income portfolio.
That’s the challenge that many bond-only income products face today.
A 30-year bond bull market has been a massive boon for income portfolios heavily reliant on credit. In a falling yield environment, you can reap the full benefits of corporate bond yields — and many investors have pushed into riskier and high-spread exposures.
This has been very supportive for credit as an asset class. But the game is now changing.
The 30-year bond bull-run has come to a close. Inflation is the market zeitgeist. Any traditional income portfolio will lack the necessary levers to confront it.
Rising bond yields need to be hedged. Those hedges eat into the already scant levels of income such portfolios are now generating.
A rising yield environment will also cause more dispersion in the performance of credit. Portfolios that have loaded up on lower quality offerings in recent years are likely to see more headwinds.
That’s why Pendal’s income strategies look very different to those traditional income portfolios.
High-quality credit serves as an essential income building block, but the overall portfolio needs other levers to manoeuvre through different market environments.
If the environment is inflationary, there need to be other sources of income besides fixed rate credit.
The Pendal Monthly Income Plus Fund currently has a 19% allocation to Australia equities, with room to add further.
This is not only a way to help the portfolio keep up with the reflation narrative. The income from equity dividends frees us from relying heavily on accruals from fixed rate instruments.
As a result, the Monthly Income Plus Fund’s exposure to interest rate risk is the lowest it’s been for more than five years.
Importantly, should sentiment suddenly turn more bearish, de-risking will be far easier in equities than in credit due to its liquidity advantage.
In the Pendal Dynamic Income Fund, a 20% allocation to floating rate emerging market sovereign exposure helps generate additional income, while capturing the spread compression opportunity as investors seek portfolio diversification from asset classes such as Emerging Markets.
Similarly, the Dynamic Income Fund’s interest rate exposure is currently minimal.
Having non-traditional levers to gain additional exposure to income and market upside has given us the luxury to not chase lower quality credit deals when they come to the market.
Instead, cognisant of the rising yield environment, we are running higher-than-normal cash balances that are waiting to be deployed at more attractive yield (and hence income) levels.
Flexibility via multiple levers, a focus on quality, and agility on interest rate exposures are the makings of a resilient income portfolio.
Amy is Pendal’s Head of Income Strategies. She has extensive experience and expertise in emerging markets, global high yield and investment grade credit and holds an honours degree in economics from Cambridge University.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2021 the team won Lonsec’s Active Fixed Income Fund of the Year Award. In 2020 they won the Australian Fixed Interest category in the Zenith awards.
The team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.Find out more about Pendal’s fixed interest strategies here
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at October 28, 2021.
PFSL is the responsible entity and issuer of units in the Pendal Monthly Income Plus Fund (ARSN: 137 707 996) and Pendal Dynamic Income Fund (ARSN: 622 750 734) (Funds). A product disclosure statement (PDS) is available for the Funds and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Funds is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Funds.
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