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Income diversifier enters the local scene
WHEN it comes to looking for income, investors tend to focus on traditional assets that offer them a stream of cash flow such as blue chip equities that pay out dividends, and fixed income segments such as Asian bonds, emerging market bonds, and US as well as Asian high-yield bonds.
While these traditional assets have been historically managed to deliver decent yields, many of them tend to have a high level of correlation of returns among themselves, with the recent market volatility and a rise in risk-free rates affecting several of these asset types at the same time.
Since the start of 2018, dividend-paying equities as measured by the MSCI World High Dividend Yield Index have delivered returns of -0.3 per cent, with many of the traditional high-dividend-paying stocks falling under the "bond proxy" trade label hurt by the rise in government bond yields.
The higher-yielding (and correspondingly higher-risk) segments of fixed income as represented by Asian bonds (-1.5 per cent), emerging market bonds (-2.2 per cent), US high-yield bonds (+0.2 per cent) and Asian high-yield bonds (-0.9 per cent) have failed to continue delivering their rich returns seen in 2017 (based on total returns in Sing dollar terms as at April 20.)
Given that dividend-paying equities at large and the fixed-income segments mentioned above tend to be the bread and butter of most income-focused funds in the market, investors who have tried to diversify their holdings away from these traditional sources of yield might have faced some difficulty in finding alternatives.
The recent launch of the BlackRock Dynamic High Income fund could help such investors find such diversification. While one might worry over the short track record of the product given that the fund was only officially launched in Singapore on Feb 6, 2018, the underlying strategy of the fund stretches back to November 2014, which has thus far averaged a yield of approximately 7 per cent per annum. The fund invests primarily in complementary and less commonly owned assets, that are not typically found in most of the other income-focused products available locally. While most income-focused products tend to have a significant majority of their assets invested in dividend-yielding equities and the fixed income segments mentioned above, the BlackRock Dynamic High Income fund limits its exposure to such traditional sources at 30 per cent in a normal environment.
The majority of its portfolio is where the non-traditional assets lie. These range from covered call writing, global real estate investment trusts (Reits) and institutional preferred equities for the equity sleeve, to floating rate loans, non-agency mortgages and commercial mortgages for its fixed income sleeve. On top of the non-traditional sources of income, the fund's adoption of overlay strategies sees it utilise duration hedges to help manage portfolio interest rate risk as well as developed equity index futures and treasury futures to help generate returns. The usage of overlay strategies is yet another differentiating factor from your typical plain vanilla income-focused fund.
In terms of its current portfolio allocation as at end-March, the fund has 30 per cent allocated towards covered calls on individual stocks, 20 per cent in high-yield bonds and 17 per cent in institutional preferred equities. For those new to covered calls, the usage of call options allows the fund manager to earn a premium on their underlying holdings of equities, thus generating increased income from the asset.
The timing of the usage of a covered call strategy is also important, as during times of heightened volatility, the prices of such options rise thanks to the surge in implied volatility and deliver a higher level of yield for the portfolio.
For example, the recent bout of heightened volatility saw covered call writing yields increase to roughly 14-15 per cent per annum, compared with an average of 10-12 per cent per annum in lower volatility environments. That was a yield that resulted in the fund manager seizing the opportunity for clients during the market sell-off earlier in the year.
Yield-hungry investors might wish to note that as at the end of March, the underlying assets of the BlackRock Dynamic High Income Fund had an underlying yield of about 7 per cent per annum - a figure which is rather attractive given that among the traditional sources of income, the highest yields on offer today stems from the high-yield sector where yields are around the 6 per cent range per annum at the expense of taking on credit risk.
Admittedly, while the product is indeed a complement for existing traditional sources of yield, it should not be seen as a replacement of all of one's existing holdings, given that the product's strategy seeks a risk profile that is more in line with a 70 per cent equity-30 per cent bond portfolio. This risk profile could lead the fund to experience more volatility during periods of heightened market gyrations, although judging by the manner in which the fund managers reacted in February, such market conditions are likely to provide more opportunities for the managers to take advantage of.
If investors are seeking to diversify one's income-generating assets, the BlackRock Dynamic High Income fund does appear to offer them the opportunity to do so given its ability to gain exposure to less common asset classes and the flexibility to allocate between traditional and non-traditional sources of income.
- The writer is the assistant director of the research and content team at fundsupermart.com (FSM). FSM is the business-to-consumer division of iFAST Financial Pte Ltd, the Singapore subsidiary of iFAST Corporation Ltd.