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In Volatile Times, Fund Managers Seek Risk-Averse Income: Morningstar Panel

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“It’s no surprise people are looking for income,” said Morningstar fund-of-funds analyst Jeff Holt, as he kicked off a final session at the 2015 Morningstar Investment Conference in Chicago on Friday. “And look at the [resulting] growth of these multi-asset income funds.”

Addressing a panel of three portfolio managers and an audience of several hundred advisors and other professionals, Holt pointed to a slide of the top 10 such funds with $10 billion and up in assets.

The Franklin Income Fund (FKINX), for instance, has about $93 billion, while the JP Morgan Income Fund (JNBAX) has nearly $13 billion and the BlackRock Multi-Asset Income Investor Fund (BAICX) about $12 billion.  

“The typical investor … is very risk aware and sensitive to the loss of capital,” said Michael Fredericks, head of U.S. retail asset allocation at BlackRock and portfolio manager of BAICX, which has a trailing-12-month yield of 4.74% according to Morningstar.

“We want to be risk adverse when it comes to income … and not overstretch for yield, and we especially want to do well in down market,” Fredericks said.

Looking ahead, the investment expert says the firm’s strategy of the past few years is not likely “to work so well going forward, so we look to be flexible as we navigate a rising rate environment.”

In addition, the fund manager says his team is “willing to sacrifice income if valuations don’t look very attractive, last summer’s bond prices, when there’s not much upside left.” Over all, the BlackRock manager says, the fund “advertises a 4% to 6% yield, which is very sustainable,” according to Fredericks.

Managers of JP Morgan’s income fund believe investors “have to spend risk to get return and to get income,” said portfolio manager Anne Lester, “and we help them do that as efficiently as possible when it comes to the tradeoff.” As for where the fund makes its bets on risk, “We put money into equities and preferred [stocks] with similar yields and potential for upside. That’s a pro-risk view of the portfolio, which we aren’t expected to have forever.” (The JP Morgan Income Builder has a trailing-12-month yield of 4.22%.)

“We ask what kind of risk do I want to expose the investors to?” explained Ed Perks, chief investment officer of the Franklin Equity Group. “That drives our positions in the portfolio …, and the asset mix has switched [around] a lot in the past decade, as credit spreads have declined.” (The Franklin Income Fund has a trailing-12-month yield of 4.98%.)

“We look for diversified income. As we shift from investment grade to high yield, we might expose you to same risk, and that is important for the investor to know,” Perks said. “We think about, as the markets evolve, where is the best price to find income and total return?”

Future Performance

In the current climate in which “the fixed-income party is not quite over,” Lester says the JPMorgan team looks at what performance is sustainable. The firm is fairly bearish on the U.S. economy and thus “look for other ways to play our [macro] view out in high-yield investments, REITs and preferred.”

For Franklin, it focuses on what it likes and will own multiple securities from the same company, Perks said. “Where value exists, we like to think of these investments in the aggregate … which leads to nice opportunities, especially around fixed-income exposure.”

For BlackRock, rising rates has the firm and its income funds “positioning ourselves for a shift from stocks that are high dividend payers to more cyclical stocks,” Fredericks said. “If the U.S. economy gets more momentum, high-dividend stocks are OK, but they aren’t likely to lead the market higher.”

Thus, he adds, the group’s income fund managers are moving some equity holdings into cyclical stocks with covered call options. “And we can be short in duration … on the fixed-income side.”

As for what is keeping the fund managers up at night, Lester says it’s not credit risk but it is duration and duration risk. “We want to spend our risk dollars in equities” right now, she explained.

But JP Morgan overall is bullish on Europe. “It is not going to go down in flames,” Lester stated. Franklin’s income team is looking more at convertibles, and BlackRock at closed-end funds.

As the income experts anticipate rising rates, their focus is on “setting expectations now about lower returns and higher volatility,” said Lester. “We do not think world is going to end or have a crash or 20% pullback  … but the market is not expected to be as good as has been.”