Capital IdeasTM
Investment insights from Capital Group
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Edward Harrold
There is a new reality taking shape in global markets and investors may need to reset their expectations.
Perhaps the highest-profile shift is the return of inflation. Even as global inflation begins to subside, consensus data suggests levels will remain well above where they have been over recent decades.
Investors, regardless of where they are based, may have to look beyond their domestic market for income-generating assets.
Traditional sources of income have been disrupted
The pandemic and its aftermath have increased idiosyncratic risk for investors looking to generate income. For example:
- Disrupted supply chains and labour market shortages have aggravated inflation pressures.
- Covid shutdowns and regulatory pressure led to the cancellation of many dividends in developed markets, particularly Europe, though many have now been reinstated.
- Instability in the banking sector in 2023 led to a rise in volatility for bond markets and valuations.
- Commercial real estate, particularly office and retail sectors, have come under pressure from tighter lending conditions.
As traditional sources of income come under pressure, investors will need to evaluate how they continue to meet income goals. One approach is to complement these traditional assets with higher-income solutions to generate a reliable income stream to help withstand inflation and help smooth periods of market volatility.
Higher inflation requires higher-income solutions
Yield on assets compared with US Consumer Prices Index
Past results are not a guarantee of future results.
Data covers period from 31 July 2010 to 31 July 23. Inflation is based on US Consumer Price Index (CPI) (all items) annual percentage. Global equities represented by dividend yield of MSCI All Country World Index, global bonds represented by yield-to-worst of Bloomberg Global Aggregate Bond Index, global real estate represented by dividend yield of MSCI Global Real Estate Index. High yield represented by yield-to-worst of JPMorgan US Corporate High Yield 2% Issuer Index. Emerging market debt represented by yield-to-worst of JP Morgan EMBI Global Diversified Index. Sources: Bloomberg, Capital Group
The complementary role of global high income
Most investors will understand the benefits of combining assets with different attributes to reduce risk – but diversification can also be a key part of generating a consistent high income from an investment portfolio.
An approach that combines higher-yielding fixed income sectors such as corporate high yield and global emerging market debt could complement domestic strategies in the following ways:
- Higher yield potential: Despite rises in developed market investment-grade bond yields, with current yields at 3.8%[1], they remain below or roughly in line with inflation, depending on where investors are based. In contrast, US high yield bonds and emerging market hard currency debt, as measured by their respective indices, offer yields of 8.4% and 8.1%, respectively.[2]
Higher yield not only presents the potential for higher income, it is also a key driver of total returns. A consistent high level of income can help to smooth periods of volatility and deliver a compelling long-term total return, which could offer a smoother ride for investors.
- Country diversification: Rising political and economic risk have created a challenging backdrop for investors in both developed and emerging markets. That being the case, greater exposure to global assets could help provide more consistent income.
There are 25 developed corporate high yield markets and more than 80 countries with emerging sovereign and corporate bond markets. The combination of high yield and emerging market bonds gives investors access to a deep opportunity set with much greater economic diversification.
- Differentiated risk and return drivers: A broader investment universe expands the opportunity set, which allows investors to draw on a wider range of return drivers. Tapping into different return drivers allows investors to diversify credit risk by region, sector, quality and issue. It also raises the potential for more diversified interest rate and currency exposure.
Combining two of the highest-yielding bond markets — emerging market debt (EMD) and high yield bonds — could not only help increase the income available but could also amplify diversification benefits without taking on excessive additional risk.
[1] As at 31 July 2023. Global investment grade bonds measured by yield-to-worst of Bloomberg Global Aggregate Index. Source: Bloomberg Aladdin
[2] As at 31 July 2023. US High yield measured by yield to maturity (YTM) of Bloomberg US High Yield 2% Issuer Cap Index, emerging market hard currency debt measured by JPMorgan EMBI Global Diversified Index. Source: BlackRock Aladdin
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