Think long-term, think income.

Quick Read

• Though traditional balanced portfolios with meaningful exposure to megacap growth stocks have been enjoying their time in the sun over the past few years, we urge investors to remember that income-oriented portfolios have historically offered stronger long-term risk-adjusted returns.
• Moreover, taking an income-oriented approach is crucial for retirees with regular distribution needs to avoid depleting their savings. We illustrate how blending an income portfolio with a traditional 60/40 portfolio can achieve risk-adjusted results over time.
• Looking ahead, the outlook for many income asset classes is promising. Dividend stocks currently exhibit attractive relative value compared to richer growth stocks. Meanwhile, both higher yielding bonds like bank loans and several more defensive areas of fixed income currently offer uniquely elevated income opportunities.

As megacap technology stocks have taken center stage amidst the Artificial Intelligence frenzy, income-oriented portfolios that lean into areas like dividend stocks and higher yielding bonds have moved to the background. Despite this recent – and admittedly meaningful - performance gap, it’s important to adopt a longer-term lens.

To illustrate this point, we looked back over a 25-year period at different blends of an income-oriented portfolio (comprised of MSCI World High Dividend Index, Bloomberg High Yield Bond Index, and US Agg) versus a traditional portfolio (comprised of MSCI World and the US Agg). As shown below, the diversified blended income portfolios in orange have generally delivered better returns for similar levels of risk across the spectrum. In other words, the income portfolio efficient frontier is higher than the traditional portfolio efficient frontier over the 25-year period.

Income for the future

While an income-oriented approach may not be the most appropriate solution for all investors, particularly those in their accumulation phase looking to strictly grow assets, it is incredibly important for investors in or approaching retirement, who need distributions to help meet their living expense needs. We delved into this topic in depth in a previous insight article.

One way retirees or pre-retirees can start making this transition is by allocating towards a 40/60 income-oriented portfolio from a traditional 60/40 portfolio in smaller increments. The chart below shows that over the last 25 years, as an investor adds more to an income portfolio in 10% increments, not only does the portfolio risk go down, but the returns improve as well.

What’s ahead for income investors?

As with any asset class, performance differences between traditional portfolios and income-oriented portfolios are likely to change as the market environment evolves. As the analyses above illustrate, taking a diversified approach to income investing that incorporates dividend stocks, higher yielding bonds and defensive fixed income can create an all-weather approach that delivers attractive risk-adjusted returns and yields for retirees. Let’s dig into our outlook for each of these buckets:

Equity income. As mentioned, dividend stocks have materially lagged broader equities since the end of 2021 but today they exhibit much more reasonable valuations. For instance, the MSCI USA High Dividend Index’s current price-to-earnings multiple is just 16x compared to the S&P 500 at 21x (Bloomberg as of July 2024). Today, growth remains remarkably resilient, inflation has fallen materially, and the Fed is now on the precipice of an easing cycle. We continue to view the probability of recession as low and view dividend stocks as an attractive way to play for upside. We believe covered calls are another segment of the equity income market that are particularly attractive in the current environment. Covered calls refer to owning a stock and selling away a portion of the upside in the form of a ‘call option’ to earn a premium. Heading into what is likely to be a volatile election season, a strategy that can monetize this uncertainty in the form of higher option premiums could be particularly compelling.

Higher yielding bonds. Our team continues to like floating rate bank loans. Compared to fixed rate securities of a similar credit quality like high yield bonds, bank loans today offer wider spreads and higher yields. Meanwhile, robust earnings data suggest that corporate fundamentals remain healthy, and the risk of widespread defaults are low. These attributes combined with the fact that bank loans are floating rate in nature and thereby their prices are insulated from changes in interest rates make this segment of the fixed income market uniquely captivating today.

Defensive fixed income. Finally, it is important to balance equity and credit exposures with high quality bond positions to provide ballast to a portfolio. Today, coupons in cash and short-term investment grade bonds appear attractive. These high quality bonds can help mitigate portfolio volatility while also offering a reliable income stream. In addition, we like high-quality, AAA-rated collateralized loan obligations (or “CLOs”), which are simply pools of individual bank loans grouped by quality. Historically, no AAA or AA tranche has ever experienced a credit loss. Moreover, this tranche today offers a 2% yield advantage over the Bloomberg US Aggregate bond Index.

Bring it all together.

In conclusion, amid the AI boom and the surge in tech stocks, income-oriented portfolios remain invaluable. Despite short-term performance disparities, the long-term advantages of Multi-Asset Income funds and model portfolios cannot be ignored.

Performance data represents past performance and does not guarantee future results. Investment return and principal value will fluctuate with market conditions and may be lower or higher when you sell your shares. Current performance may differ from the performance shown.

To obtain more information on the fund(s) including the Morningstar time period ratings and standardized average annual total returns as of the most recent calendar quarter and current month-end, please click on the fund tile. The Morningstar Rating for funds, or "star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.

BlackRock provides compensation in connection with obtaining or using third-party ratings and rankings.

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