Last updated: 13:25 / Wednesday, 7 October 2015
Analysis by BlackRock

Flexibility, Risk and Diversification: the Keys to Optimize Income

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Flexibility, Risk and Diversification: the Keys to Optimize Income
  • In a world where, in many cases, interest rates are below inflation, finding sustainable sources of income is proving ever more challenging
  • Currently, less than 20% of the outstanding debt on the market exceeds a yield of 4%; an unthinkable scenario only a few years ago
  • In order to make informed decisions about income-oriented strategies, it proves import to understand the key characteristics and risks of these different asset classes

On looking back at the asset management industry, the past few years have seen significant changes in the investment landscape. One that is affecting most investors is the levels of yield of their investments. In a world where, in many cases, interest rates are below inflation, finding sustainable sources of income is proving ever more challenging. Fixed income, the traditional source of income, has been hit particularly hard by easy monetary policies. Currently, less than 20% of the outstanding debt on the market exceeds a yield of 4%; an unthinkable scenario only a few years ago.

In such an environment, investors should look to have a more holistic approach to income generation, diversifying the sources of yield and reaching across non-traditional asset classes to achieve their income goals. For example, within the fixed income asset class, investors can diversify their holdings to incorporate sectors such as high yield corporate bonds and emerging market debt that still offer attractive yields

For those who have access to physical assets, some alternative investments carry attractive income opportunities, such as real estate or infrastructure funds due to the low correlation to the market that they offer.

However, for a successful diversified income portfolio, yield levels should not be the sole factor in defining one’s allocation. Income growth is crucial to ensure targets are reached and income growth outpaces inflation. Dividend paying companies can often play this role.

“By investing in stable companies with records of paying and growing dividends, there is a higher probability that your income portfolio can keep pace with the rising cost of living […]. In this asset class, we prefer Europe over any other developed market” highlights BlackRock.

With interest rates near record lows, investors have been looking for opportunities in these new areas. But navigating through the current environment has become more challenging. In order to make informed decisions about income-oriented strategies, it proves import to understand the key characteristics and risks of these different asset classes

Many investors reaching for higher yields have increased the risk profile of their portfolios and are often unaware that they are doing so. This is where diversification can play a crucial role in ensuring that a portfolio is not over-exposed to a particular type of risk. It is also important to be aware of new risks that need to be considered such as issuer risk for credit exposures, foreign exchange, liquidity risk and equity volatility.

According to BlackRock “Striking a balance between what investment outcome needs to be achieved and the acceptable risk level to achieve it, is arguably the single most important principle in building an income portfolio.”

This material is for educational purposes only and does not constitute investment advice nor an offer or solicitation to sell or a solicitation of an offer to buy any shares of any Fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that some or all of the funds have not been registered with the securities regulator in any Latin American country and thus might not be publicly offered within any such country. The securities regulators of such countries have not confirmed the accuracy of any information contained herein.

 

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