(Dow Jones) A focus on yield may benefit investors as the U.S. economy transitions from recovery to growth, a period when markets often display range-bound returns and heightened volatility, independent broker-dealer LPL Financial Corp. said in its mid-year outlook.
Seeking opportunities in the face of headwinds and benefits from elevated volatility as well as using a more active rebalancing approach may also help investors, LPL said in the outlook posted to its web site.
"We believe a higher yield may benefit portfolios by providing a consistent income component that is received regardless of price movements, cushioning downward moves," it said.
Among the yield-focused investments it suggests are high-yield bonds, real-estate investment trusts, emerging-market bonds and dividend-paying stocks. In addition to offering a solid yield, high-yield bonds benefit from contracting yield spreads and the improving financial conditions of underlying issuers, it said.
REITs possess stable fundamentals that may benefit from economic growth and a further increase in employment and their fundamentals tend to recover later in the economic recovery/expansion cycle than most other industries, "suggesting more improvement to come," LPL said. "Also, given their low correlation to other income-generating investments, REITs have historically been able to help improve portfolio diversification--also a benefit in periods of volatility."
Emerging-market bonds offer solid income opportunities, and exposure to fast-growing economies with less risk than investing directly in emerging-market equities, LPL said. As for dividend-paying stocks, with investment returns likely muted during the second half, they may make the difference "between market-beating and market-lagging results," it said.
With headwinds on the rise, one attractive strategy is to seek investments that tend to benefit when many others struggle, including those that may thrive in periods of potentially rising interest rates, increasing tax rates and the shift to restrictive monetary policies, LPL said. Bank loans, for example, normally benefit as interest rates increase because their adjustable-rate features reset to higher yields, it said. Commodities benefit from rising inflation and soaring price increases; stand to benefit from the global economic recovery, especially in China and the surrounding region; and offer potential hedges against a weakening U.S. dollar, it said.
In addition, municipal bonds offer attractive yields, especially on an after-tax basis, given the likely political pressure for higher taxes to pay for soaring government debt, LPL said. Also, with the likely continuation of headwinds from slowing growth in Europe, small-cap equities "could be relative return winners" since small-cap companies are more domestically focused and could be better insulated if a contagion develops, it said.
To benefit from increased volatility, LPL suggests alternative strategies, such as global macro and investment vehicles exposed to long/short and covered calls, which may offer diversification and some risk reduction. Large-blend stocks can offer a solid yield and less cyclical exposure of predominantly blue-chip names, both attractive characteristics, which may offer insulation from unexpected market swings, it said.
It also suggests that investors "buy the dips and trim the rips." A more active rebalancing strategy can position portfolios aggressively when volatility presents opportunity, but defensively when it suggests danger, LPL said. Investors may implement such portfolio shifts with balanced strategies that opportunistically transition assets.
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