The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. 

Bonds are often the go-to-choice for many income investors around the world. And they certainly have their advantages. They’re typically less volatile than equities, can provide a stable income, and if you buy them at issue and hold them to maturity, you likely get your money back (unless the issuer defaults). So, any income-generating portfolio should certainly contain an element of bonds.

However, when it comes to income, bonds aren’t the whole story. Other forms of income – including infrastructure stocks, healthcare, telecoms, and other non-cyclicals – may present a solution for investors seeking more diverse income strategies within their portfolios.

The recent high levels of volatility in the bond market certainly make the case for diversifying your income portfolio. Over the past two years or so, bonds have experienced unusually high levels of volatility. Bond yields had been falling globally since the 1980s, reaching their nadir in early 2020 in response to the extraordinarily loose monetary policies adopted by central banks during the pandemic. By December 2020, 27% of the world’s investment-grade debt provided a negative yield, a disastrous outcome for investors dependent on bonds for this income.

Since then, yields have rebounded, leaving many investors nursing potential capital losses. Moreover, the outlook for the fixed-income sector in the short term remains uncertain. Just a few months back, investors were piling into bonds in the belief that interest rates would fall as inflation eased, but that view is now being questioned given the surprising resilience of inflation and economic activity in the US.

Figure 1: US Treasury bond yields, 1962-2023

Source: Bloomberg, M&G as of 31 August 2023.

Expanded horizons and beyond traditional fixed income

The challenge for income investors is that, while bonds currently offer attractive yields, the situation could reverse very rapidly. The constantly changing outlook for bonds underlines why investors need more than just bonds in their income arsenal – and fortunately there are plenty of options to choose from.

Equity income

The traditional 60/40 model, in which 60% of a portfolio is designated to stocks to drive capital growth and 40% to bonds to generate income, remains valid despite the losses both bonds and stocks suffered in 2022. Before 2022, there were only two calendar years in which both stocks and bonds declined: 1931 and 1969.¹ Indeed, the March 2023 banking crisis again demonstrated the wisdom of this approach: while equities tumbled, prices for US Treasuries and other bonds soared.

Having exposure to equity income strategies therefore continues to make sense. These strategies seek to deliver income and allow capital growth by investing globally, regionally, or in specific stock markets. They tend to focus on well-established, financially healthy companies with a record of growing dividend payouts, so prices – while typically more volatile than those for bonds – tend to be more stable than in other sectors of the stock market. Equity income strategies also tend to generate a higher income than bonds – and one which have the potential for  capital and dividends growth over time.

Infrastructure income

Building infrastructure income strategies into a portfolio, meanwhile, brings stable income flows that are often linked to inflation, exposure to long-term structural growth trends. Income comes from investing in the stocks of companies that provide key infrastructure services, in sectors such as energy, transport, hospitals, universities and data centres.

Moreover, these stocks provide diversification to traditional equities. These companies are relatively lower risk, given that they generally provide essential services - such as providing drinking water or distributing  energy - that people require almost irrespective of the state of the economy. This makes the asset-class potentially much attractive in periods of economic weakness. Infrastructure income strategies may  provide a higher income than bonds and are less volatile than global equities in general. However, they are less stable than bonds and can be adversely affected by higher interest rates.

The advantages of a flexible approach

Exposure to different instruments across a broad range of sectors helps create flexibility, as different instruments will react independently during the economic cycle and geopolitical upheaval. Seeking income from a range of equities and regions - and not just bonds - helps to diversify your portfolio, giving you the freedom to remain invested and successfully navigate short-term market dips. Aligning your portfolio towards different aspects of income may also help to lower drawdowns, allowing you to capture potential new investment opportunities.

Sources:
¹ https://www.marketwatch.com/story/60-40-portfolio-dead-or-alive-11673385267