Is there a simpler way to invest for income in portfolios?

The knee-jerk reaction is to look for yield in fixed income, according to Adam Hetts, vice president and head of portfolio construction services at Janus Henderson Investors.

But there may be an easier way.

“What we’re seeing generally is reaching for yield way too far in the fixed income portion of the portfolio, and taking what we see as too much risk in most fixed income allocations,” Hetts said.

In a recent meeting with ThinkAdvisor, Hetts discussed the findings of some new research about how income investing can be simplified.

“Income has not been easy since the global financial crisis and since interest rates hit historical lows globally and are still floating around historical lows,” Hetts said. “People still want income; especially a lot of advisor clients just want income.”

These clients want yield for day-to-day needs and for emotional safety in case there’s a downturn in the market, Hetts explained.

The problem is that increased innovation and a proliferation of new income investment solutions that have created too much complexity and risk in portfolios.

“A lot of new products being built are getting increasingly complex with leverage, with derivatives, with global strategies, [and] more esoteric asset classes,” Hetts said. “Our view is that they’ve worked — obviously. There have been rainbows and sunshine across a lot of the higher yielding income asset classes. We’re a little more concerned with what happens when the tide goes out.”

As the research paper — “Income Investing Simplified” — written by Hetts and his team, states, income innovation has been welcome in this world of historically low global interest rates. However, the paper also states that “many of these new solutions are stretching the risk boundaries of traditional income asset classes by utilizing increasingly complex and esoteric instruments.”

The paper points to Morningstar data showing that 19% of U.S. large blend funds, 21% of intermediate-term bond funds, 28% of multisector bond funds and 47% of nontraditional bond funds were launched within the last five years.

According to the paper, the speed of innovation in some fixed income categories has created a secondary challenge within income investing: simplicity. The combination of relatively short track records and new innovation creates difficulties in articulating expectations to clients.

“Our view: As an investor, don’t just look at the yield of your portfolio but look at the complexity with which that yield is being created — and the amount of derivatives, leverage [and] esoteric asset classes that are being deployed to get to those yield goals,” Hetts explained. “And to what extent are you going to be able to articulate the expectations of those exposures to your end clients?”

So, how can advisors simplify their income investments? Hetts and his team suggest advisors first look at their equity allocations.

“We believe income portfolios can better serve client needs, depending on their risk tolerance, through a globally balanced equity allocation complemented with a goals-based approach to fixed income,” the paper states.

Hetts and his team looked at the typical equity allocation — based on their proprietary database of thousands of advisor portfolios — and found that at least half of many income portfolios are allocated to equities and the vast majority of those equities are commonly invested in the U.S.

“Equities continue to show a strong home bias to U.S. equities,” Hetts explained. “The average advisor is half the weight of overseas equities that the global indices would suggest they should be at from a neutral perspective.”

According to Hetts, most of the income opportunities are overseas.

“Going global with your equities, you can double or triple your dividend yield compared to U.S. equities. While at the same time, kind of globalizing and optimizing a biased portfolio,” he said.

According to the paper, this global rotation in equities could “likely be an income-increasing and risk-decreasing move” for income portfolios.

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