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Generating income through safe investments like U.S. Treasurys was once was an easy move.
Now, not so much.
With yields on those government-issued bonds near zero, investors may need to add some risk to the income side of their portfolio.
“Twenty years ago, generating income was a one-trick pony,” said Lauren Ferry, head of portfolio strategies at Nuveen. “We could just invest in U.S. Treasurys.
“The situation today is so much more complex.”
Speaking Tuesday at the CNBC Financial Advisor Summit, a day-long virtual conference for financial advisors, Ferry addressed how to enhance income in today’s environment.
While inflation is one of the ever-present risks with bond investing, the Federal Reserve recently indicated that it likely won’t step in any time soon to stop it.
This effectively means that the central bank’s typical reaction to the specter of inflation — raising its benchmark interest rate, which taps the brakes on assumed inflationary pressures — may not happen as soon as it would have otherwise. Thus, inflation could go above the target rate of 2% at some point.
Ferry said at the CNBC summit that Nuveen advises clients to remain invested and to diversify the risk in their income portfolios.
“Not all yields are created equal,” she said.
For example, consider two asset classes: emerging-market debt and senior loans (corporate debt secured by collateral). While their yields are both close to 6%, the underlying risks differ, Ferry said.
For instance, emerging market debt is more sensitive to equity markets, she said. Senior loans, on the other hand, have more sensitivity to credit risks (i.e., the risk of default).
“Knowing what drives these asset classes, whether it’s interest rates, credit or equity markets, and then having a forward-looking view on those drivers — this is what helps us construct diversified [income] portfolios,” Ferry said.
She also recommends against holding cash. With interest rates as low as they are compared with inflation, it means your cash is losing buying power the longer it sits there.
“Think about real yields … we’re in negative territory when you account for inflation,” Ferry said. “It’s like filling your canteen with water before going on a long hike, and then you reach your destination and realize you’ve had a leak the whole time.
“That’s the impact of inflation,” she said.
You also can consider adding alternatives to your portfolio to diversify your risk and sources of income. For instance, private credit (debt of private companies vs. publicly traded ones) could complement your core bond investments, according to Ferry.
“But there is a trade-off … it could be introducing more illiquidity,” she said. “You can probably give up a little bit of liquidity for that extra yield premium.”