- The current real (inflation-adjusted) yields of U.S. Government-related bonds are only modestly positive.
- U.S. Government and related bonds, with yields near record-low levels, cannot mathematically produce the same returns as they have over the past three and a half decades.
- Low-coupon, long-duration bonds are particularly vulnerable to a rise in interest rates.
We believe income-focused investors have not yet responded to these challenges in their portfolios.
Current Positioning Compounds the Challenge
According to Morningstar, investors currently allocate more than 70% of their income portfolios in U.S. Government bonds and investment-grade corporate bonds, with a smattering of other income-generating assets comprising the remainder of their portfolios.
The results are income allocations within portfolios that we believe are more suited for the past than the present.
Investors do have options, however, in today’s fixed income and alternatives world in the form of asset classes that focus on areas beyond the Bloomberg Barclays U.S. Aggregate Bond Index. In our view, such assets as high-yield bonds, international bonds, senior loans, and specialized alternatives (e.g., event-linked bonds, dividend-paying equities, preferred stock, and master limited partnerships) can all compliment a core bond allocation and help investors who are seeking to generate income.
Our recent white paper offer three portfolio suggestions for different yield objectives based on a Black-Litterman Optimization framework. The targets for yield are 3.5%, 4.5%, and 5.5%. The goals of the optimizations are to provide guideposts for investors as they seek to build new income portfolios out of asset classes beyond the Bloomberg Barclays U.S. Aggregate Bond Index. This framework helps with evaluating how many different asset classes could fit together without over-allocating to specific risks.
The paper features the optimization results and explains how investors seeking income can develop new portfolio construction approaches for today’s market environment.
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The mention of specific securities or sectors does not constitute a recommendation by any particular fund or by OppenheimerFunds, Inc.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns and does not assure a profit or protect against loss.
Bonds are exposed to credit and interest rate risk. Interest rate risk is the risk that rising interest rates or an expectation of rising interest rates in the near future, will cause the values of a fund's investments to decline. Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historic lows. When interest rates rise, bond prices generally fall, and a fund's share prices can fall. Foreign investments may be volatile and involve additional expenses and special risks. Senior loans are typically lower-rated and may be illiquid investments (which may not have a ready market). Investing in MLPs involves additional risks compared to the risks of common stock, including risks related to cash flow, dilution, and voting rights. Alternative asset classes may be volatile and are subject to liquidity risk. There is no guarantee that the issuers of stocks will declare dividends in the future, or that dividends will remain at their current levels or increase over time. Diversification does not guarantee profit or protect against loss.