Harnessing income amidst market uncertainty

Key takeaways:

• 2025 so far has been unpredictable and rife with uncertainty. Concerns on inflation, tariff policy, geopolitics and shifting equity assumptions on AI build out have led to a stuttering start to the year for markets. It’s as important as ever for investors to stay diligent, diversified, and adaptable in order to capitalize on opportunities and mitigate risk.
• Diversified income-generating portfolios can perform well in these conditions. By balancing a mixture of fixed income and equity exposures as well as non-traditional income seeking instruments, multi-asset income portfolios can provide more predictable returns through dividends and coupons, making them a valuable strategy for investors.
• Below we demonstrate how through a diversified approach leaning into floating rate loans, covered calls on stocks, and options strategies on credit assets, income portfolios can flourish despite the uncertain outlook for 2025.

2025 has started with a bang! Bond yields have been on a rollercoaster ride, spiking on inflation fears then cooling off then spiking again in February with hotter-than-expected CPI data, only to fall again as growth worries gripped the market more recently. The AI sensation DeepSeek threw a curveball at the equity markets, causing tech stocks to tumble just weeks after the S&P 500 hit record highs. Although we don’t see this as a major near-term risk to AI capex investment, it’s a reminder that the competitive dynamics are very real, and investors should be wary of the high expectations embedded into current prices. Moreover, the new administration's tariff announcements have kept the markets on their toes.

Amid uncertainty, income can be a more predictable driver of total return than price appreciation alone given the greater consistency of dividend and coupon payments. For investors in their retirement phase, its particularly important to consider an income-generating portfolio to meet spending needs so as to mitigate the risk of ‘dollar cost ravaging,’ the concept of running out of principal to fund retirement spending. In these uncertain times, the Multi-Asset Income Fund and model portfolios are seeking to take advantage of fluctuating yields and unexpected market moves to generate attractive returns. So, where does this leave our outlooks and asset class views for the rest of the year…?

On growth: Consensus expectations for 2025 are optimistic, contrasting with the more cautious outlooks of 2023 and 2024. Consumption over the past two years has been powered by strong job growth coupled with robust wage growth. We expect both to slow as this year wears on. Additionally, some of the key pillars of corporate investment (e.g. manufacturing structures, transportation and IT equipment) are showing signs of fatigue, and there isn’t a clear candidate to pickup the slack. A higher starting point means there is a greater potential for disappointment, so we remain more balanced in our risk taking (vs. prior years), having built more diversifying exposures into the strategy creating the space to add risk on market pullbacks.

Evolution of US real GDP growth forecasts

On Equities: AI innovation is now better reflected in Mag 7* earnings forecasts, with continued double-digit growth expected for 2025 but lower than the past two years. Conversely, earnings growth expectations for the S&P more broadly are expected to be higher this year than last. As this earnings convergence plays out, we expect strong returns from areas that have lagged over the last few years and now benefit from more attractive valuations. We believe US dividend growth stocks will deliver accelerating earnings growth this year and are well-positioned to benefit from a broadening in equity market performance. For income investors, what this means is potential price upside on top of already attractive dividends from these companies.

Earnings growth broadening out

With lower return expectations for equity markets in 2025 (due to elevated valuations), covered calls provide another attractive way to balance income generation with upside capture, thereby enhancing overall portfolio yield and returns. In the Multi-Asset Income Fund, for example, we write covered call options on individual stocks, monetizing market volatility to drive additional income. Currently, covered calls represent 15% of the Fund’s exposure but drive 36% of the overall yield. The other benefit of this approach also allows our strategies to benefit from areas in the equity market that are underrepresented in traditional dividend-oriented equity strategies.

On Credit: Spreads are very tight for both investment grade (IG) bonds (88bp) and high yield (HY) bonds (290bp), reflecting low default rates, favorable economic conditions, and strong corporate earnings. Most returns will come from coupon payments due to limited room for price appreciation. Emphasizing income with a risk-adjusted focus helps minimizes volatility in this environment.

We are focusing on floating rate exposures, preferring loans over HY due to high carry and lower volatility. AAA-rated CLOs (collateralized loan obligations) remain an attractive part of the fixed income universe that continues to perform well. In US IG, we prefer the intermediate part of the curve, as the yield premium for extending duration is insufficient given low overall spreads and a flat credit curve.

Another way to deliver a differentiated source of income is by considering option strategies on credit fixed income assets. These strategies, known as Fixed Income BuyWrites, offer attractive monthly cash flow through the sale of at- or near-the-money call options while offering some downside protection in a down market via the premium earned from sale of the call option.

Rate markets have been volatile this year. 10y treasury yields peaked at 4.79% in January before falling sharply. A shock CPI print in February then sent yields higher again. Unlike prior years, we expect rates markets to broadly drift sideways in 2025 with volatility offering opportunities for tactical trades. On the positive side, expectations for Fed easing are more realistic, but the possibility of greater fiscal deficits (and the ensuing treasury supply) could push yields higher depending on government fiscal priorities.

Conclusion

As we progress through 2025, we stay adaptable in our approach and committed to being dynamic to effectively manage risks and capitalize on opportunities. Diversifying income-producing instruments is a wise strategy to secure stable yields and achieve competitive returns.

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