For many years, dividend stocks were one of the few places where investors could find decent yields in a world of ultralow rates. A 10-year Treasury bond was dealing out an emaciated 1.3% a year ago, less than half the 3% yield in dividend-rich sectors like utilities.
That has changed. Attractive yields are cropping up across the bond landscape and parts of the stock market. “There’s a lot more income today than there was at the start of the year,” says Kelsey Berro, a portfolio manager at J.P. Morgan Asset Management.
There’s still no free lunch. Bond yields move inversely to prices, and that dynamic has walloped returns, as falling prices swamp the gains from interest income. “We have had a historic fixed-income selloff,” says Anders Persson, chief investment officer for global fixed income at Nuveen.
The 10-year U.S. Treasury note yields 3.27%, after doubling since January. That has left investors with a minus 11.9% total return, including interest. Diversifying hasn’t helped much. The iShares Core U.S. Aggregate Bond exchange-traded fund (ticker: AGG), a market proxy that includes 24% of its assets in corporate debt and 27% in mortgage-backed securities, is down 10.3% this year.
The headwinds aren’t likely to abate, with the Federal Reserve recently turning more hawkish, according to Chairman Jerome Powell’s recent speech in Jackson Hole, Wyo. Markets now anticipate a “higher for longer” climate for rates. Investors should also brace for more volatility as the markets scrutinize every economic data point for more signs of Fed tightening…or easing.
This selloff, however, has opened opportunities across income-generating assets. “Whether it’s fixed income, the equity side, or anything in between, the income component has become more attractive,” says Mark Freeman, chief investment officer at Socorro Asset Management.
Berro, for one, is moving away from high-yield bonds and emphasizing investment-grade credits with shorter maturities. That should help reduce sensitivity to rates. She also likes asset-backed securities, such as automobile loans. “The U.S. consumer balance sheet is in a relatively good position, with low debt-service ratios,” she says, adding that such asset-backed loans yield an average 4.1%.
Gibson Smith, who co-managed fixed income at Janus Henderson and now runs his own firm, views the front end of the yield curve as the riskiest segment. “The $64,000 question is: How much higher will rates go on the front end?” he says. “The higher rates go, the greater the risk of a slower-growth trajectory.”
Smith and his team manage the ALPS/Smith Total Return Bond fund (SMTHX), which has slightly edged the broad bond market this year with a minus 9.7% total return. As yields climbed, the fund lowered its exposure to credit, particularly junk and investment-grade bonds issued by financial companies. He recently added to the fund’s holdings in longer-dated Treasuries, especially in the 20- to 30-year maturity range.
Longer-term Treasuries are highly rate-sensitive, which scares off many bond managers. Smith takes a contrarian view, arguing that the Fed’s aggressive actions now will bring down inflation, propping up long-term bonds. “The more aggressive the Fed, the more supportive that is of the long end of the market,” he argues.
Mohit Mittal, co-manager of the Pimco Dynamic Bond fund (PUBAX), sees value in agency mortgage-backed securities, known as MBS. The bonds “have cheapened as markets price in the Fed’s balance-sheet reduction,” he says. MBS yield an average 4.5%, though total returns will hinge on factors like housing demand and the Fed’s plans for shrinking the $2.7 trillion in MBS on its balance sheet.
Two other ways to invest: the Vanguard Mortgage-Backed Securities ETF (VMBS) and the Janus Henderson Mortgage-Backed Securities ETF (JMBS). Both yield around 2.5%.
Also in housing, Mittal likes nonagency mortgage securities, which aren’t backed by a government entity, such as Fannie Mae or Freddie Mac. “The home-price appreciation we have seen over the past couple of years has meant that loan-to-value ratios have improved in favor of bond investors,” he says, adding that nonagency MBS yield an average 5.25%.
Another way to play that theme is the Semper MBS Total Return fund (SEMOX), which has a big weighting in nonagency mortgages. It has a low duration and 5.1% yield.
Carl Kaufman, chief investment officer at Osterweis Capital Management, sees opportunities in dividend stocks. “Longer term, companies with a history of growing dividends have been pretty good performers,” he says.
The Osterweis Growth & Income
fund’s (OSTVX) top holdings include Microsoft (MSFT), Johnson & Johnson (JNJ) and CVS Health (CVS). Microsoft yields only 0.9%, but is raising its payout steadily, he points out. J & J and CVS both yield more than 2%, and he expects steady payout growth at both companies.
One sector that looks dicey is real estate investment trusts, or REITs. Real estate firms are under pressure from climbing rates and fears of a recession. The Real Estate Select Sector SPDR fund (XLRE), which tracks the industry, is off 17.9% this year.
Freeman says he has cut his fund’s REIT holdings in half, to about 8%. “Longer term, we like the asset class,” he says, “but we want to see what happens from a recession standpoint.”
Write to Lawrence C. Strauss at lawrence.strauss@barrons.com
Source: finance.yahoo.com