Do your clients feel confident about their sources of income? Advisors may feel like Chicken Little from the fable, “The Sky is Falling” with their discussions about the potential of a raising interest rate environment. While we have only seen one Fed rate increase in the past 10 years, indications are that they may raise rates in the coming months.
Despite the growing probability that rates will rise, the current climate is still driving clients to riskier asset classes for yield. In some cases, they may not be aware of the extent of the risks they are assuming. Given these conditions, it could be time to add additional eggs to your clients’ proverbial basket of income streams.
Historically low yields and the possibility of interest rate hikes pose significant challenges to investors looking for income.
An Alternative Approach to Portfolio Construction
A traditional portfolio construction in these conditions might make a client’s income stream less predictable and more susceptible to losses. Alternative income strategies strive to maintain attractive yield while still managing risk. These approaches invest in a wide range of income sources including traditional income assets such as investment grade and high yield bonds, income-oriented equities, REITs and alternative strategies (including hedges). Professional managers can make tactical adjustments in an effort to manage risk and capture emerging opportunities.
Alternative income strategies are intended to provide:
- Differentiated sources of income
- Enhanced diversification through low correlations to traditional assets
- Reduced portfolio sensitivity to rising interest rates
If these goals are accomplished, alternative income investments may help reinforce the reliability of a client’s income sources. The resulting portfolio should have broader income diversification and improved risk mitigation in the event of rising interest rates.
When putting a strategy together, we suggest adding an alternative income fund with:
- Limited overlap with traditional bond allocations for better risk-adjusted return potential
- Multi-strategy portfolio construction to avoid single strategy volatility
- Active management to alleviate the unwanted exposure of passive investments
Video: Learn more about alternative income strategies.
Diversification does not assure a profit nor does it protect against loss of principal.
Alternative mutual funds often hold a variety of non-traditional investments and often employ more complex trading strategies than traditional mutual funds. Each of these alternative asset classes and investment strategies have unique risks, typically making them more suitable for investors with an above average tolerance for risk. Investors should fully understand the asset classes, investment strategies and their risks before investing.