Emerging market bonds may also benefit from more robust price appreciation, according to Scott Service at Loomis Sayles. “Many of these countries had been aggressively raising interest rates until recently, and now they’re in a rate-cutting cycle,” he says, which tends to boost bond returns.
Satya Patel, a portfolio manager at the Matthews Asia Credit Opportunities Fund (MCRDX), likes Asian bonds in particular. “The yields you can get are pretty attractive, and there are a host of positives in place. For example, he notes that the credit for Asian high-yield bonds is currently in line with historical averages. In contrast, European and U.S. high-yield spreads are 200 to 300 basis points tighter than their historical average.
And he adds that Asia bond high-yield default rates “are very low these days, around 3%.” That’s the result of a thriving regional economy. As the International Monetary Fund noted in its most recent global survey, “the outlook for the Asia-Pacific region remains robust—the strongest in the world, in fact—and recent data point to a pickup in momentum.”
The Matthews Asia Credit Opportunities Fund carries a solid 4.37% one-year trailing yield. Another option is the VanEck Vectors Emerging Markets High Yield Bond ETF (HYEM), which carries a 0.40% expense ratio and a very appealing 6.49% trailing yield, good enough for a four-star rating from Morningstar.
The Other Half Of The Stock/Bond Axis
Of course, equities also provide a range of income opportunities as well, with dividend yields often exceeding bond yields. But such stocks aren’t immune to rising interest rates either. Fisher’s Anderson notes that REITs, telecoms, master limited partnerships and utilities may feel the impact of rising rates. In his search for dividend yields, he is focusing his time these days on European stocks. “They have been unloved, compared to U.S. equities, which is reflected in their valuations,” says Anderson. “There’s still a fair bit of caution about the region, but the economic measures out of Europe are quite good these days.”
Anderson singles out European banks for mention. “Their yields are appealing, and we’re seeing rising lending rates in Europe, whereas lending rates in the U.S. are flattening.”
The bullish European view is shared by Thornburg’s McMahon, who notes that the average European dividend yield (outside the U.K.) stands at 3.7%, well above the 2.0% average yield seen in the U.S. The Thornburg Investment Income Builder fund (TIBIX) carries a 3.97% trailing-12-month yield and has 55% of its assets invested in financial services, communication services and energy.
He singles out JP Morgan Chase, the fund’s second-largest holding, as a firm that meets the fund’s mandate of stable and growing income streams. “Their dividend could just about double considering the excess capital they’ve built up,” he says.
Few income investment strategists sing the praises of the U.S. right now. “I don’t see a case for stronger economic growth in the U.S.,” says Bryce Fegley, portfolio manager of the Sextant Global High Income fund (SGHIX). And he adds that U.S. equities are notably more expensive than their global peers.
Fegley and his management team can shift assets between stocks and bonds as they see fit to capture the best returns for capital preservation. The fund currently has a roughly 50% weighting in bonds and around 30% in foreign stocks, according to Morningstar.
A Place For MLPs?
As noted earlier, some income-producing equities may struggle to retain their value if fixed-income yields begin to siphon away interest. Savita Subramanian, Merrill Lynch’s head of U.S. equity and quantitative strategy, is not a fan of utilities or REITs in this environment. “Sell stocks that look like bonds and buy stocks that look like stocks,” she said in an August 1 conference call. Telecoms that carry decent yields are also flagged by Subramanian, as she suggests avoiding firms with high levels of debt (which would see a spike in the interest expense on it).
Energy MLPs, while carrying similar interest rate risk, at least offer comparatively robust yields. And they are surely worth consideration if you believe that oil prices will remain stable and you are not expecting much interest rate movement.
These partnerships span the spectrum from stable low-yielders to more volatile high-yielders. Rather than focus on the right firm, the JPMorgan Alerian MLP Index ETN (AMJ) brings a basket approach, tracking the payouts of more than three dozen such firms.
To be sure, erratic energy prices and volumes can lead to variable dividend distributions. The 2017 payouts for this exchange-traded note, for example, are on track to be around 10% lower than the 2016 $2.08 per unit distribution. Still, the current pace of payouts reflects a roughly 6.5% annualized yield.