Finding income in surprising places

The quest to provide income during retirement has never been as daunting as it is today. Bonds, the old standby for income, have both historically low yields and the risk of rising interest rates wiping away principal. That’s forcing advisers to think outside the box and look at different asset classes to replace that income.
So why is Michael Fredericks, portfolio manager of the $5.1 billion BlackRock Multi-Asset Income Fund, feeling upbeat about non-dividend-paying stocks, and cutting his exposure to master limited partnerships and floating rate loans?
InvestmentNews: What income-generating asset classes are you favoring today?
Mr. Fredericks: Stocks are still very attractive. I don’t think there’s another big leg up in the equity market, but it could continue to grind higher. Industrial-type companies are still attractively valued. The problems is, those types of stocks don’t have a lot of yield. So we use a short-term call-writing program to supplement the income.
Europe is another area we’ve been increasingly upbeat about. At the beginning of the summer, we had very little exposure, but now valuations have some catalysts behind them. The data out of Europe is getting less bad, or even improving. We’ve initiated allocations to high-dividend-yielding stocks in Europe, and high-yield bonds. There’s positive momentum there.
InvestmentNews: What about the classic dividend-paying stocks, like utilities and consumer staples?
Mr. Fredericks: They still merit a substantial position, but after the equity market rally year-to-date, the multiples have expanded considerably. To be realistic, advisers need to dampen their return expectations for these companies. But they should feel comfortable because these are terrific franchises, in many cases. They’ve typically held up better than the broad market in sell-offs.
InvestmentNews: What asset classes have you been cutting back on?
Mr. Fredericks: At one point, we had about 8% of the fund’s assets invested in MLPs but that’s down to about 1.5% today. They do generate a good amount of income. Our issue is, they have really rallied a lot. Valuations are quite stretched. There’s nothing wrong with the fundamentals, but the price you have to pay is a little excessive right now.
We liked the bank loan market a lot a year ago. Last year, we were at around 14%. Now we’re down to 3%. Again, the rise in the valuation has made these not nearly as attractive as they were. LIBOR plus 400 basis points may not be significant income for the risk you’re taking.
InvestmentNews: Quantitative easing has played a big role in the markets for the last few years. Are you starting to prepare the fund for tapering?
Mr. Fredericks: Everyone is placing their bets for early 2014. We’re doing the same thing. We’ve been cutting back on risk. We’ve cut back on equities and high-yield bond exposure and added short-duration, very-high-quality bonds. I think a lot of these asset classes will still do OK next year, but there could be an acceleration in volatility.
InvestmentNews: Broker-dealers are holding far fewer bonds on their balance sheets today than before the financial crisis. How has that impacted trading bonds?
Mr. Fredericks: Every adviser should be considering the liquidity of the positions they hold. The sell-side can’t serve as a sponge anymore. There’d be a problem if everyone tries to get out at once. In the past, high yield and floating rate had a sell-side cushion, but the intermediary’s ability to do that is really diminished. Advisers need to think about allocations to these segments of fixed income. There’s a lot of tourist dollars this year. It may prove to be hot money.