Dr. Brian Jacobsen shares three ideas for income-seeking investors when income seems scarce.
Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. Income-oriented investors may be finding that income is, well, hard to find. And that inspired Dr. Brian Jacobsen, Senior Investment Strategist with the Wells Fargo Asset Management Multi-Asset Solutions Team, to put income investing under the microscope. Brian, welcome to the program.
Brian Jacobsen: Thank you for having me.
Laurie: This will be the first of three episodes in a mini-series where we’re following three AdvantageVoice® blog posts that Brian authored on the subject of fixed-income investing. This conversation stems from his January 25 post called “Income under the microscope: Splitting signal from noise.” Brian, what inspired you to write this piece?
Brian: Well, one of the big things that inspired it was just that in talking to clients and prospects, some of the harder conversations (and maybe more interesting conversations) are around that idea of creating income considering the low-interest rate and low-yielding environment that we’re in and have been in for quite a while now.
Laurie: And in the post—which I should let our audience know has useful and compelling charts—your research indicates that income returns can be more significant and have more stable returns from assets (as measured by standard deviation) than returns from an asset’s price changes. And tying back to the post’s title, you wrote: “For many assets, the income return is the signal while the price return can be the noise.” Can you explain that?
Brian: When you look at the data, the income portion of a portfolio’s return is typically the least risky and also most significant part of the return. We have a chart that shows the breakdown of the average annual percentage of total return than comes from income. The high-yield bond index can be over 121% of the total return—at least that’s what it was during the 1997 to 2017 period—mainly because with high-yield bonds, most of your return was from income because we’ve seen a slight decline in prices over that time period, because of a slight move up in interest rates. But then you compare it to something like small-cap stocks, and there, the income portion is only responsible for around 16% of the total return. So, it’s still a decent chunk, but it’s not the bulk of it. So, depending on the asset class that you’re looking at, income should be in focus, maybe, to different degrees.
Laurie: Well, let’s talk about this in terms of how your team is approaching finding income in a low-yield environment from a multi-asset class perspective.
You wrote that you believe there are three keys to generating income in today’s environment, the first one being casting a wide net. Can you explain that?
Brian: I think that it’s important to cast a wide net in the sense of looking across asset classes and looking across geographies. Most people, when they think about investing for income, the first thing that probably comes to mind would be, like, high-yield bonds or municipal bonds, maybe dividend-paying stocks. Oftentimes they are thinking something very U.S.-centric, but it’s a big world out there. Instead of just a U.S.-oriented equity income strategy, maybe consider making it more global. Instead of just thinking of U.S. high yield, you can also consider looking at emerging market debt. Or, believe it or not, even some of the debt that’s issued in Europe and even in Japan could be attractive, especially when you consider exchange rate changes. And that’s where when you fold in some of these foreign exchange considerations, the pool is actually a lot bigger and a lot deeper than what people might originally have thought.
Laurie: Okay. Second, you suggest: Resist the temptation of extremely high yields.
Brian: Yes. One of the dangers is that you take a look at what dividends did a company pay, then just assume that they are going to continue paying that into the future. Sometimes those dividends can be at risk. Sometimes you can encounter issues where maybe if the dividend yield is suddenly very high, what it’s actually telling you is that the future dividend is going to be cut—not that it’s going to be maintained. The market is basically telling you it’s pricing in a lower dividend yield than what might be seen on first appearance, based upon the trailing dividends that have been paid. And very similarly on the fixed-income side, where if you see very high yields there, perhaps that’s actually reflecting a very high risk of default. So, it’s not just a matter of stretching for as much yield as you can, it’s looking for sustainable income and doing it in a risk-managed way.
Laurie: And third was an interesting view on price volatility.
Brian: This is where “separating the signal from the noise” comes in. It’s very easy, I think, to get distracted by the day-to-day ups and downs of the market. Lately, we just went through a market correction—very abrupt. But how many people panicked over that because of that abrupt move down?
If you panicked and sold at the bottom, in hindsight, we now know that was a mistake because things have rebounded. Now, in real-time, the spur-of-the-moment, you don’t know is it’s a prelude to a further decline. And so if you are indeed an income-oriented investor, really I think it’s about trying to identify how sustainable is that [income] going forward over time? And then, in that case, the price can kind of do whatever it does.
Laurie: Very good. I’ll remind our audience to visit our blog AdvantageVoice® to stay informed on this topic as well as others. But for now, Brian, thank you very much.
Brian: Thanks for having me.
Laurie: Until next time, I’m Laurie King; take care.