Income investing: Embracing innovation for smarter returns

CONTRIBUTORS

Christy Tan

Senior investment Strategist
Franklin Templeton Institute

In today’s uncertain economic environment, the value of a stable income stream is crucial. It is essential to equip portfolios with solutions to navigate high interest rates and inflation. As asset managers, it is imperative to navigate these complexities with astute investment strategies.

The recent FuTure forum in Hong Kong highlighted two key income strategies for challenging markets: Asian fixed income and a blended income approach. Stephen Dover, Chief Market Strategist at Franklin Templeton Institute, led a panel with Desmond Soon from Western Asset Management and Subash Pillai from Franklin Templeton Investment Solutions.

Here are my key takeaways from the discussion:

Asian fixed income offers both diversification and the potential for higher yields, compared to bonds from developed economies such as the US or Europe. Asia has fairly large local currency markets and the inclusion of Asian bonds in global benchmarks is expected to improve market liquidity and attract more investors. The forward path of interest rate normalisation in Asia has also presented favourable entry points.
The panel advised against focusing solely on high returns, emphasizing the need to minimize default risks for more stable long-term gains. In addition, investors are encouraged to align their liabilities and assets more closely to diversify against traditional exposures. For instance, investors can consider holding a diversified basket of Asian local bonds for yield enhancement and currency risk mitigation.
In addition, a multi-asset portfolio can also provide diversified and consistent income¹ streams. Multi-asset investing has been growing in popularity in the past few years, Franklin Templeton has already built a track record of more than 75 years, with its first strategy launched as far back as 1948.
Operating within an unconstrained investment universe, portfolio managers can dynamically allocate among equities, fixed income, and other income-generating asset classes in response to changes in market movements, inflation and interest rates. For example, in early 2022, Franklin Templeton’s multi-asset portfolio managers shifted from an equity-heavy portfolio to a more bond-focused approach due to rising interest rates and slowing global growth.
Taking a multi-dimensional approach, our portfolio managers diversify even within each asset class. For instance, they allocate across a mix of investment grade, high yield and US government bonds while managing duration actively. At the same time, they retain the agility to rotate back to equities when conditions are deemed to be more favourable.

An innovative aspect is the use of equity-linked notes (ELNs) to complement common stock holdings. Our multi-asset portfolio managers employ additional options to maximise income. Combining the features of fixed income and equities, ELNs offer both yield and price upside potential. Their structured cap limits the maximum return, making it akin to a covered call strategy². This approach offers more diversity than traditional income strategies and can be especially useful for investing in growth sectors like technology.

Conclusion

To broaden the opportunities for income generation, our portfolio managers adopt a more flexible approach to transcend conventional stock/bond diversification. The alignment of one’s assets and liabilities, as well as being nimble and innovative in gaining exposure to growth opportunities can ensure consistent relatively income across market conditions.

ENDNOTES

Income is not guaranteed.
In a covered call strategy, one holds stocks and then sells (writes) call options on the same stocks. This approach generates income through the premiums received from selling the options. If the stock price stays below the option’s strike price, one keeps the stock and the premium. If the stock price exceeds the strike price, one may have to sell the stock at that price, but still keeps the premium.

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