Finding income amid low interest rates and bond yields

Jan 8, 2014 @ 12:00 am

Runtime: 6:04

Mark Freeman, chief investment officer of the Westwood Holdings Group, discusses how the search for income has changed in an environment of low interest rates and little yield from bonds.

Video Transcript

Finding income without taking undue risk has been a constant theme of ours on WealthTrack and this week's guest has a successful track record of doing both. Mark Freeman is Chief Investment Officer at Westwood Holdings Group. He succeeded now-retired Great Investor Susan Byrne at that job in 2012. Among his many responsibilities, he is Senior Portfolio Manager of the Westwood Income Opportunity Fund, which he launched in 2005. The conservative allocation fund is a Morningstar favorite because of its "attractive total return with moderate risk." I began the interview by asking Freeman how his search for income opportunities has changed during these years of low interest rates and low bond yields. -That's a great question and I think-- you know, when I think back about it over the last several years, the way it's changed is, ultimately, it's not really from a process standpoint or ultimately in terms of what we're looking for, but what's really changed is, where do you find it? And I look back, and if you look at, say, the top level across our asset allocation, that's what's changed, and that asset allocation reflects where we're finding those opportunities that offer income but also growth, but again, it's not-- it's not static. It doesn't stay in just one part of the market, and the fixed income market is a perfect example. -So, you know, let's talk about how your asset-- -Sure. -allocation has changed, because right now, more than 50 percent of the portfolio in the fund is in stocks or, you know, common stocks or,-- -Right. -what, preferred convertibles or preferred stocks, and so, you know, which is a-- traditionally, that's a heavier weighting than you would normally have. Correct? -It is. It is from the-- on a historical basis. -Right. -As a matter of fact, at the beginning, there was-- we had-- fixed income was roughly 45 percent-- -You mean in the beginning in 2005 when you started the fund? -for the-- for the mutual-- for the strategy. -Right. -Exactly right, because again, that was a time and a place where we could actually find attractive opportunities in fixed income, and so now, if you fast forward to today, and we all know what's happened in terms of interest rates and them being at extremely low levels today, you know, our fixed income exposure has come down rather significantly. We're probably now in the mid-teens in terms of fixed income exposure, but at the same time, our equity exposure has really done the opposite. It's gone from roughly mid-teens to, as you mentioned now, in the really-- roughly high 40 percent of the portfolio. -You are a new face to our WealthTrack viewers. I'm delighted to have you here. Your, you know, predecessor, Susan Byrne, at Westwood Holdings, who's now retired, was not a new face, but I'd love to know, you know, what your investment objectives are with-- -Right. -with the Income Opportunity Fund and also, you know, talk to us a little bit about process as well. -Sure. Let me-- Let me kind of, as you said, let's-- like take a step back and-- -Right. -and kind of give you a little bit of history of the strategy. So, when we started it, we started it because our clients were coming to us because of what had taken place in the bond market and the rates had fallen rather dramatically, and they were saying, "Look, there's gotta be something better out there, okay? A better alternative to the return profile that we're seeing in fixed income." And so, we said, "Look, okay, that's great." But what they were also saying was that, you know, "We want-- We want a better return profile, but in many ways, we still want the volatility profile or the low volatility profile that comes with-- that fixed income investors had typically experienced. And so, ultimately, what they were saying is like, "We would like to earn an attractive total rate of return but with an acceptable, i.e., low level of overall volatility in the portfolio." -Right, and low-level volatility compared to the stock market. -Absolutely. -Okay. -Certainly, less than a pure equity type of-- type of product,-- -Right. -because at that time, that was really the traditional mindset, and really that was really from a product offering. That's all there was. You could either have fixed income or you could go into "equity income products" which were basically just dividend-- purely dividend-paying stocks, but they still had the same volatility profile as roughly the equity market. And so, that really wasn't a suitable solution for what those investors were asking for. So, we literally just took a blank sheet of paper and said, "Okay, how do we solve this problem?" And ultimately, we tried to come up with a solution, and the income opportunity strategy was the end result. And so, ultimately, we said, "Well, look, how do we do this?" We'll use income-producing securities, and we'll use those from up to eight different asset classes. Okay, so that gives us the diversification. But I think what's also important to understand is, what is the role of income? Okay. Why is income so important? And I think-- I think everyone understands it from the return standpoint. Okay, here's the yield and everyone has cash in hand, and you can get that, but it's also very important on a total return basis. It gives you a nice foundation. If you can add 2, 3, 4 percent yield and then add a capital appreciation component, you then generate on a total return basis what I think is a pretty attractive overall total return profile. -Speaking of low risk, and lower risk than the stock market,-- -Uh-huh. -so when I look at your portfolio today, for instance,-- -Uh-huh. -with more than 50 percent in stocks,-- -Right. -how do you address the-- how do you avoid the risk that you've got in stocks? -Well, I think there's a couple of different ways and one reflects Westwood's philosophy in terms of the type of companies that we invest in, and those are companies that are what we perceive to be as very high quality. They have strong balance sheets. They're generating high levels of free cash flow. So, when you look at those metrics, typically, those are-- those are companies that tend to have a lower volatility profile, certainly less so than those companies that, say, have no earnings or let alone pay dividends or maybe they have distressed balance sheets. And so, that's-- really, our investment philosophy is really the starting point that takes us in that direction in terms of limiting volatility.


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