With interest rates nearing zero and stalwart companies cutting dividends, income investing is more challenging than ever before. However, just because it is challenging does not mean it is impossible. For insights on how income-investors can effectively adapt to the current economic environment, ThinkAdvisor recently spoke with Principal Street Partners CEO James West.
According to West, one strategy that income-investors may want to revisit is bonds. Traditionally, bonds served three roles in diversified portfolios: income generation, low volatility and as a hedge against stocks. Now, with the U.S. Treasury note remaining at less than 1%, bonds’ ability to generate income is severely limited.
“For investors who were invested in bonds prior to the downturn, you have some of those higher-coupon bonds,” West explains. “You definitely want to hold on to them because they’ll protect you better if rates go up.”
Bonds’ second role of tempering market volatility has also been somewhat diminished. “If we do get rising interest rates, that volatility is going to increase,” says West. Despite this, bonds can still effectively be used as a hedge against stocks, as seen with their first-quarter outperformance. “Even with historically low rates, tax-exempt areas, such as in the municipal high-yield sector and short-duration muni bonds, remain attractive,” West explains.
In addition to bonds, West also recommends that income investors rethink how they select their stocks. While it is still important to use traditional metrics to analyze companies, the pandemic has created the need for further due diligence. For example, West recommends avoiding sectors that can be adversely affected by COVID-19, such as companies that rely on having large groups of people in contained spaces and evaluating companies’ leverage levels compared to industry peers.
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