Monthly Market Commentary
Supporting Portfolios with Alternative Sources of Income
Philip Blancato, Chief Market Strategist, Advisor Group
Amid heightened market turbulence fueled by increasing uncertainty over slowing economic growth, persistently high inflation, and rising interest rates, investors have rightly grown concerned about capital preservation within portfolios. Growth shares and “long duration stocks,” or those valued almost entirely on far-off cash flows and future growth expectations, have come under significant pressure resulting from the torrid pace of interest rate hikes this year, which has hampered total return. Traditional sources of diversification and income generation have failed to deliver on both fronts as fixed income markets, particularly the relatively conservative investment-grade sector, posted their worst start to a year in history. Also consider the increased correlation of risk assets at elevated levels of inflation, and the portfolio construction “trilemma,”i or balancing the three primary objectives of total return, capital preservation, and income generation, becomes all the more difficult.
Investors now facing a market environment seemingly fraught with pitfalls and no obvious place to hide can combat these challenges by focusing on alternative sources of income. Examples of these are numerous and varied; strategies can be as simple as prioritizing high and growing dividend payers and as complex as a hedging strategy overlay that delivers equity market exposure with limited volatility and flexible income generation. Consistent income in and of itself, however, can help dampen portfolio volatility in chaotic markets and boost total return, as “historically, reinvested dividends have been the primary driver of total returns for stocks.”ii Here, we highlight a few alternative income sources and asset classes that Ladenburg employs across our income model portfolios.
Short Duration Income
- As most income portfolios feature fixed income heavily, if not exclusively, it cannot be understated how crucial it is to remain squarely short duration in a rapidly rising interest rate environment. Investors should target funds that prioritize capital preservation and liquidity by actively managing risk on a broader set of short duration, investment-grade money market and fixed income securities. This will allow for delivery of higher income potential than other short-term investments and help shore up bond portfolios in one of the most challenging fixed income markets ever.
- As mentioned above, a hedging strategy overlaying a defensive equity portfolio selected based on a bottom-up, fundamental research process and risk-adjusted stock rankings, has the potential to generate an impressive level of income by selling financial instruments which the portfolio underlies. These strategies often provide limited market upside potential in exchange for greater downside protection, as well as lower volatility and beta than the S&P 500 Index without adding duration.
- High and growing dividend payers can provide some similar benefits as a hedged portfolio. The larger income component acts as a total return “floor” of sorts, and the defensive nature of dividend paying stocks should deliver lower volatility and beta than the index, although price return remains uncapped on both the upside and the downside.
Floating Rate Loans
- Floating rate bank loans have been a robust allocation across Ladenburg model portfolios amidst the rising rate environment in 2022. Year-to-date bank loans have significantly outperformed the Bloomberg Aggregate Bond Index and most other nominal fixed income. This, of course, is due to the floating rate feature inherent with loans, the coupons of which pay a spread above a reference rate like LIBOR or SOFR, and those reset with prevailing interest rates. Current yield levels have historically implied strong forward-looking returns, and the floating rate aspect ensures investors are paid to wait around with increasing coupons that better withstand the effects of high inflation.
One final note regarding dividends: the consistency and security of company payouts is closely linked to their ability to generate free cash flow. The corporations with the highest levels of free cash flow are best positioned to deliver reliable dividends. That said, dividend payer or not, the most important thing investors should remember is to simply stay invested. Bear markets tend to be short and the rebounds quick; despite poor performance year-to-date, now is a critical time to stomach the volatility ahead and stand ready to reap the early, and often most significant, returns off the market bottom.
Unemployment Rate: The unemployment rate tracks the number of unemployed persons as a percentage of the labor force (the total number of employed plus unemployed). These figures generally come from a household labor force survey.
CPI (headline and core): Consumer prices (CPI) are a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
S&P 500: The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
NASDAQ: The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.
Bloomberg Barclays US Agg Bond: The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate passthroughs), ABS and CMBS (agency and non-agency).
Index performance does not reflect the deduction of any fees and expenses, and if deducted, performance would be reduced. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance cannot guarantee future results.
The statements provided herein are based solely on the opinions of the Advisor Group Research Team and are being provided for general information purposes only. Neither the information nor any opinion expressed constitutes an offer or a solicitation to buy or sell any securities or other financial instruments. Any opinions provided herein should not be relied upon for investment decisions and may differ from those of other departments or divisions of Advisor Group or its affiliates. Certain information may be based on information received from sources the Advisor Group Research Team considers reliable; however, the accuracy and completeness of such information cannot be guaranteed. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial information. Any opinions, projections, forecasts and forward-looking statements presented herein reflect the judgment of the Advisor Group Research Team only as of the date of this document and are subject to change without notice. Advisor Group has no obligation to provide updates or changes to these opinions, projections, forecasts and forward-looking statements. Advisor Group is not soliciting or recommending any action based on any information in this document.
Securities and investment advisory services are offered through the firms: FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., Triad Advisors, LLC, and Woodbury Financial Services, Inc., broker-dealers, registered investment advisers, and members of FINRA and SIPC. Securities are offered through Securities America, Inc., a broker-dealer and member of FINRA and SIPC. Advisory services are offered through Arbor Point Advisors, LLC, Ladenburg Thalmann Asset Management, Inc., Securities America Advisors, Inc., and Triad Hybrid Solutions, LLC, registered investment advisers. Advisory programs offered by FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., Securities America Advisors, Inc., Triad Advisors, LLC., and Woodbury Financial Services, Inc., are sponsored by VISION2020 Wealth Management Corp., an affiliated registered investment adviser. Advisor Group, Inc. is an affiliate of these firms. 4934858
i Fidelity Investments, “Portfolio Construction for Income” Fidelity Investments Webinar (August 24, 2022).
ii Pacer ETFs, “Invest in Dividend Payers with Free Cash Flow” The Pacer Perspective (June 2022).