Fixed Income June 2017  

How to construct a portfolio for yield

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How to build a robust yield into a portfolio

How to construct a portfolio for yield

Diversification is a word that trips off the tongue of nearly everyone in the fund management industry these days – a far cry from the heady days of the tech boom.

According to Chris Leyland, deputy chief investment officer for True Potential, it is important to “have a broad spread of income sources” in a portfolio.

He says: “If just one investment fails to deliver its promised income payment, the shortfall has to be made up from elsewhere or the overall fund yield will fall.

“By incorporating many different investments in our models, we lessen the dependency on any one source.”

Chris Iggo, chief executive of fixed income at AXA Investment Managers, comments: “Diversification across sources of yield is crucial to generating long-term income, and this should be achieved at both the asset class and sub-asset class level.”

According to Mr Iggo, a well diversified bond portfolio may typically have 100 to 120 individual holdings with exposure to parts of the market that are offering the most attractive risk/return profile.

He says: “At present, we see particular diversification opportunities in emerging market debt, high yield, and financial corporates.”

Darius McDermott, managing director of Chelsea Financial Services, comments: “A diverse stream of income means that you aren't reliant on one asset class providing the yield and, as it ebbs and flows, the balance remains.”

Types of income

Stephen Crewe, director of Fulcrum Asset Management, believes generating even a 4 per cent income from a portfolio has “required an increasingly risky investment strategy".

“Currently, the expected risk entailed in a 4 per cent income has not been detrimental” but he warns this could increase the potential for a shock. Therefore, it is important to de-risk portfolios, especially for clients approaching retirement.

According to Mr Leyland, proper income diversification means increasing the “opportunity set” for capturing yield for investors while spreading and therefore lessening, the risk.

To do this, he said it is important to use specialist bond managers who can target “corporate self-help situations where spreads against government bonds are wide and then narrow as balance sheets are repaired.”

Where can yield come from?

  • Government bonds.
  • Overseas government bonds.
  • Corporate debt/investment grade debt.
  • T1 or T2 bank bonds.
  • Overseas corporate/investment grade debt.
  • UK high yield.
  • Overseas high yield.
  • Special situations.
  • Equity dividends.
  • Property income.
  • Short-duration bonds.
  • Inflation-linked bonds.
  • Social impact bonds.
  • Cash/money market funds.

Diversification across different types of fixed income and different geography is therefore key, according to Dan Ivascyn and Alfred Murata, managers of the Pimco Income fund.

Mr Murata comments: “A multi-sector approach provides the ability to seek out the best income-generating ideas in any market climate, targeting multiple sources of income from a global opportunity set.

“We diversify across multiple measures: across different regions, various credit sectors, and along the risk spectrum as appropriate with the fund’s objectives. We also balance our exposures.

“We are careful not to let portfolio volatility and returns be dominated by a single risk position.”

Eugene Philalithis, portfolio manager for the Fidelity Multi-Asset Income fund, is adamant that while asset class correlations have risen in recent years, the lower volatility of fixed income means “there is still value” in holding it.