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Why Investors Should Rethink Traditional Income Strategies

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Why Investors Should Rethink Traditional Income Strategies

income strategies

Why Investors Should Rethink Traditional Income Strategies

Humans are creatures of habit. We all have daily routines, whether it’s walking the same lunchtime route, watching a familiar TV show, or cooking the same meal over and over again. Once we develop a pattern, it can take a drastic change to convince us to rethink our approach.

One such shake-up to ingrained investment habits is the changing landscape of income investing.

In today’s infographic from New York Life Investments, we explain why traditional long-term bonds may not be as effective as they were in the past, and which additional income strategies investors can consider.

The Status Quo

For years, investors have relied on traditional longer-term bonds as the centerpiece in an income portfolio. These debt instruments usually pay out interest to investors on a predetermined schedule, providing a steady income stream investment. Historically, they have also been subject to less volatility than equities.

The typical bond portfolio is diversified, much like the Bloomberg Barclay’s U.S. Aggregate Index. Here’s how the sectors are broken down in the index:

SectorMarket Value
Treasury39.5%
Government-Related5.8%
Corporate25.0%
Securitized29.7%

Unfortunately, this income strategy has been less effective in recent years. Over the last decade, core bond duration has increased by 1.5 years while yields have decreased by almost 2%. Essentially, interest rate volatility has increased—but investors are less compensated for the risk.

In light of low rates and higher expected market volatility, it’s critical that investors explore other income solutions. Luckily, there are many lesser-known asset classes for investors to consider.

Additional Income Strategies: An Investor’s Choice

When investors decide how to re-allocate, they can keep these objectives in mind:

  1. Preservation of principal (risk level)
  2. Pursuit of capital (growth potential)
  3. Perseverance in markets (long-term objectives)

Which additional income strategies can they explore?

Taxable Municipal Bonds

Issued by state and local governments, the yield of taxable munis has historically been higher than that of other sectors. Taxable munis also have a strong credit rating—over 76% of U.S. municipal bonds outstanding are A+ rated or better.

Insured Municipal Bonds

Investors can get additional downside protection with insured municipal bonds, which are guaranteed to pay interest and principal back by private insurers. They have historically performed similar to munis while capturing less of the “downside”, often providing an attractive risk-adjusted return for income investors.

Short-duration, High-yield Bonds

Bonds with a shorter duration and higher yield can be a lower volatility approach to achieving the same income investing goals.

Yield and Risk in Bonds (July 1, 2014 – June 30, 2019):

Bond TypeYieldStandard Deviation (annualized)Yield per Unit of Risk
U.S. Aggregate Bonds2.492.940.85
High Yield Bonds6.055.601.08
Low-duration, High-yield bonds5.003.901.28

Short duration funds have lower interest rate risk, and can offer attractive yield per unit of risk.

Yield-Centric Equities

Equities can also play a role in an income focused portfolio. Investors should look for established companies that are achieving:

  • Growth in free cash flow
  • Stable or growing dividends
  • Share buybacks or debt reduction

Over the last 40+ years, the annual compound return of stocks with growing dividends have outperformed dividend cutters on the S&P 500 by more than 4%.

Preparing for Your Future

Maximizing the benefit from new income opportunities can take time. For this reason, it’s important to consider potential portfolio changes now, so that these strategies can play out in the lead up to retirement years.

It may be tempting to stick with the status quo—both in daily routines and investment strategies—but those who proactively adjust their approach will be able to maximize their potential.

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Infographics

Visualized: The Economic Benefits of a Green Recovery

A green recovery is projected to boost global GDP by 1.1% annually, along with saving 9 million jobs. What opportunities does this present for investors?

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Visualized: The Economic Benefits of a Green Recovery

After years of technological advancement, many renewable energy sources are now more efficient than traditional sources of energy.

Thanks to their falling prices and scalability, a green recovery, which centers on worldwide funding and policy support for green energy alternatives, is gaining strong momentum.

This infographic from New York Life Investments unpacks how a green recovery will benefit both the economy and investor portfolios.

What is a Green Recovery?

A green recovery is the intention of allocating the unprecedented global wave of public spending, pent up over the course of the 2020 pandemic, exclusively towards investment in sustainable systems to support:

  • The creation of millions of jobs
  • Improved productivity
  • A structural decline in greenhouse gas emissions (GHG)

Green Recovery: The Economic Benefits

It is projected that nine million jobs per year will be created or saved over the next three years in a green recovery, along with 1.1% added in global economic growth annually.

Let’s look at two reasons why a sustainable recovery is gaining traction:

  1. Lower costs in energy spending
  2. More jobs created

To start, a sustainable recovery would involve 2% of U.S. GDP invested in low carbon energy. Compare this to current U.S. energy spending, which stands at roughly 6% of GDP—sitting at near lows. In fact, in the past, energy spending in the U.S. has reached as high as 13% of GDP.

Secondly, for every $1 million investment in renewable energy, more than twice as many jobs are created per category than in traditional energy. For instance, 7.5 jobs are created in the wind energy industry versus 2.2 in oil & gas.

Per $1 Million InvestmentTypeJobs Created
Renewable EnergyEnergy Efficiency7.7
Wind7.5
Solar7.2
Traditional EnergyCoal3.1
Oil & Gas2.2

Source: World Resources Institute, 07/28/20

With this in mind, let’s take a look at how investors can take advantage of a sustainable recovery across three industries.

1. Renewable Energy

Historically, energy demand has sharply rebounded after major economic shocks.

Following the Spanish Flu, energy demand plummeted over 15%—but rebounded by almost 25% the year after. Similarly, in the years that followed the Great Depression, World War II and the Global Financial Crisis, energy demand spiked.

In 2020, energy demand growth hit a 70-year low, created by the largest absolute decline ever. If history repeats itself, energy may be poised for a substantial demand increase.

On top of this, renewables have become significantly cheaper and scalable in recent years. Solar energy is a prime example. It is now one of the most affordable sources of electricity. In fact, the price of energy from new power plants—vital sources that generate energy for society—has changed significantly over the last decade.

Energy TypePrice per MWh (2009)Price per MWh (2019)Price % Change
Coal$111$109-2%
Solar Photovoltaic$359$40-89%
Onshore Wind$135$41-70%
Gas (combined cycle)$83$56-32%

Source: Lazard Levelized Cost of Energy Analysis via Our World in Data, 01/12/20

In 2019, over 50% of new global power capacity came from solar photovoltaic and wind power.

2. Transportation

Globally, as electric vehicle (EV) sales have accelerated, so have public chargers, illustrating a new infrastructure opportunity for investors. In 2019, there were 1 million public chargers built worldwide. Since 2014, public chargers in Europe specifically have more than doubled to over 200,000.

Year# of Global Electric Vehicles
2012110,000
2013220,000
2014400,000
2015720,000
20161.2M
20171.9M
20183.3M
20194.8M

At the same time, economies are planning for a wave of green transport investments.

Italy, for instance, plans to invest $33 billion in sustainable mobility as part of its $231 billion green recovery plan. Meanwhile, Germany is investing $6 billion in the electrification and modernization of its rail and bus system. Interestingly, high-speed rail uses 12 times less energy per passenger than airplanes or road transport trips under 500 miles.

Like renewable energy, electric vehicles, high-speed rail, and modern transport infrastructure are all central to the new chapter in sustainable investment.

3. Low-carbon Technology

Finally, you can’t talk about a sustainable recovery without net-zero emissions, where all emissions created are also removed from the atmosphere.

In recent months, net-zero targets have increased substantially. In January 2020, 34% of all global emissions were covered by net-zero targets. By March 2021, this reached 50%. Decarbonization will play a critical role in reaching net-zero targets.

Crucially, net-zero emissions can be achieved through the following decarbonization options:

  • Carbon capture: Chemical absorption and the injection of CO2 into depleted reserves
  • Nuclear energy: Produces energy through nuclear reactions
  • Storage & utilization: Improved electricity grid storage
  • Renewable innovation, and others: Includes hydrogen, batteries, and scaling renewables

Even in the wake of the pandemic, global investment in decarbonization topped half a trillion dollars in 2020, 9% higher than in 2019.

New Turning Point

COVID-19 is radically reshaping the sustainable investment landscape.

In 2020, nearly 25% of all U.S. stock and bond mutual fund net inflows went into sustainable funds. By 2025, as many as half of all investments are projected to be ESG-mandated in the United States. From modern infrastructure to low-carbon tech, sustainable investments present many opportunities for investors.

Supported by lower costs and government policies, sustainable investments show potential for promising growth.

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Infographics

Beyond Bonds and Bridges: How to Approach Infrastructure Investments

Global infrastructure needs amount to $94 trillion by 2040. Here’s how to take advantage of infrastructure investments in your own portfolio.

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This infographic is available as a poster.

How to Approach Infrastructure Investments

Infrastructure is essential for our transportation, utilities, and communication needs. In fact, the U.S. government has recently emphasized its key role with supportive spending plans—and infrastructure is entering an investment supercycle.

In this graphic from New York Life Investments, we highlight the growing opportunity in infrastructure investments, and how investors can take advantage through both municipal bonds and publicly-traded infrastructure companies.

Investing in Infrastructure

As infrastructure continues to evolve, there are 3 main themes driving growth.

  • Data growth: Wide-scale tech adoption is increasing our need for digital infrastructure
  • Aging assets: Existing infrastructure is in need of upgrading or total replacement
  • Decarbonization: Climate change is driving demand for more sustainable energy

This presents a large opportunity for investors. Between 2016 and 2040, global infrastructure needs will amount to $94T, or about $3.7T per year.

Investors can access this market through municipal bonds, which are debt securities issued by state and local governments. They can also allocate funds to listed infrastructure companies, which are publicly-traded equities that own or operate infrastructure assets.

Here’s what investors need to know about both types of infrastructure investments.

Municipal Bonds

Traditionally, U.S. infrastructure is defined as big public work projects such as bridges, roads, and schools. About three-quarters of the costs are paid for by state and local governments, with a large portion coming from municipal bonds.

Both taxable and non-taxable bonds offer many benefits:

  • High Credit Quality: While corporate bonds are spread relatively evenly between investment grade and non-investment grade, the vast majority of municipal bonds are investment grade. These ratings have held up well, even during recessions.
  • Low Equity Correlation: Correlation measures how closely the price movements of two investments are related. While other bond categories have moved more in-line with the stock market, taxable municipals have had the lowest correlation. Investors who add taxable municipals to a portfolio may increase diversification.
  • Higher Relative Yields: Taxable municipal returns have been strong relative to other high quality sectors, and comparable to that of corporates.
    Bond categoryYield to worst
    Taxable Municipals2.10%
    Investment Grade Corporates1.70%
    U.S. Aggregate1.10%
    U.S. Treasuries0.60%

    Note: Data as of December 2020. Yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting.

    Amid low or even negative interest rates, this is especially important.

Infrastructure Companies

After municipal bonds are issued, governments use these funds to hire both public and private companies to build, maintain, and upgrade infrastructure. These companies have distinct advantages, such as high barriers to entry and consistent demand.

Of these companies, 360 are publicly-traded with a total value of $4.1 trillion. What benefits do public (listed) infrastructure companies offer?

  • Attractive historical returns: Listed infrastructure companies had higher returns than global equities over the 20-year period from 2000-2020.
  • Income potential: Over the last 20 years, income has accounted for about half of public infrastructure’s total return. This is partly due to stable and resilient cash flows.
  • Lower volatility and downside risk: Historically, listed infrastructure has had less risk than traditional equities and other real asset classes.
    Asset classStandard deviation Downside capture ratio vs global equities
    Listed Infrastructure12.9544.8%
    Global Equities15.14100.0%
    Global REITs17.3580.9%
    Energy Master Limited Partnerships38.25209.4%

    Note: Standard deviation and downside capture ratios are in USD over a 5 year period from Jan 2016-Dec 2020 using quarter-end data.

    For example, listed infrastructure only declined 45% as much as global equities during market downturns from 2016-2020.

An allocation to global, publicly-traded infrastructure companies may help reduce portfolio swings and manage risk.

Infrastructure Investments in a Portfolio

While municipal bonds play a key role in funding infrastructure, it’s companies that build our data centers and maintain our bridges.

Investors can benefit from allocating money to both infrastructure investments.

InvestmentWhere does it fit?Benefits
Municipal bondsCore fixed income allocation- High credit quality
- Low equity correlation
- Higher yields relative to other high quality sectors
Infrastructure companiesGlobal equity or real assets allocation- Income potential
- Attractive historical returns
- Lower volatility relative to equities & other real assets

Ultimately, municipal bonds and infrastructure companies can help investors build a stronger portfolio.

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