Thinking Tactically About Income

Scott Eldredge, Director of Fixed Income and Product Strategy at PowerShares, discusses a compelling new option for accessing multiple income strategies in one portfolio (DWIN):

For fixed income investors, we’re not in Kansas anymore. There is a witch’s brew of trends working against fixed income investors – including an economy mired in the weakest recovery since World War II, negative interest rates in Europe, the Federal Reserve having targeted 0% interest rates for seven consecutive years, quantitative easing, and the explosion of the Fed’s balance sheet – with no clear path for unwinding. These trends sow confusion, stress and uncertainty for investors struggling to construct a portfolio that can generate sufficient income.

A dearth of yield opportunities in a low interest rate environment

Given today’s low interest rates, fixed income investors clinging to a buy-and-hold mentality are hard-pressed to find yield opportunities – particularly those with aggregate bond allocations. This is because the aggregate bond universe, which has traditionally comprised a broad cross-section of investment grade securities, now looks strikingly similar to a US Treasury portfolio.

As the mortgage agencies like Fannie Mae and Freddie Mac have come under federal conservatorship, markets are pricing in little difference between agency risk and US Treasury risk. This has meant increasingly lower income for investors. How many of us could live off of a retirement income of around 2%? Well, that’s what the Barclays US Aggregate Bond Index currently has to offer.1

Pursuing income can mean taking on more risk

In a quest for higher income, many investors have taken on additional risk in the form of master limited partnerships (MLPs), high yield bonds and real estate investment trusts (REITs). These non-traditional sources of income may offer greater yields than aggregate bond portfolios, but can leave investors vulnerable to shifting market momentum – underscoring the need for credit diversification. By diversifying a non-aggregate income allocation across a broad range of investments with disparate drivers of return, investors can potentially enhance performance, while diluting the impact of market volatility.

So how does one do that? Through a “set it and forget it” allocation to a basket of income solutions with low correlation? Or is there an opportunity to be more tactical with income investing? The answer may lie in one’s interpretation of the following chart, which maps total returns by asset class over the past 10 calendar years:

This year’s winners can be next year’s losers: A decade of income performance (%)

ELDRIDGE-BLOG-0310_chart

Source: Bloomberg L.P., Barclays Capital, BofA Merrill Lynch as of Dec. 31, 2015. Data is from Dec. 31, 2006 through Dec. 31, 2015, and reflects calendar year performance. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Agg. bonds are represented by Barclays US Aggregate Bond Treasury Index, EM bonds by JPM EMBI Global Index, Preferreds by S&P US Preferred Stock Index, US REITS by Wilshire US REIT Index, Bank loans by Credit Suisse Leveraged Loan Index, MLPs by Alerian MLP Index, Municipals by Barclays Municipal Bond Index, High yield corp. by Barclays US Corporate High Yield Index, IG corp. by Barclays US Corporate Investment Grade Index, Dividend growers by S&P 500 Dividend Aristocrats Index and High dividend payers by DJ US Select Dividend Index.

As you can see, what works well one year might not work so well the next. Sometimes a poor performer can jump to the top of the heap in a relatively short amount of time, and vice versa.

A potential solution to a static income allocation

As interest rates cycle and as credit markets fluctuate, there may be an advantage to a strategy that attempts to rotate out of the weakest-performing income segments. The PowerShares DWA Tactical Multi-Asset Income Portfolio (DWIN) is a newly launched smart beta exchange-traded fund (ETF) whose underlying index methodology seeks to do just that. DWIN tracks the Dorsey Wright Multi-Asset Income Index, which invests in other ETFs and rotates between income-oriented market segments based on relative strength and yield criteria. This means investors can access market segments with high current income potential, but also attempt to defend themselves from shifting market whims.

Here’s how it works. DWIN’s underlying index starts by ranking a universe of income-oriented ETFs based on relative strength, with the top 50% of these ranked again by yield. The five top-ranking ETFs are then given equal weighting. Constituents are evaluated monthly and replaced if not among the top-yielding ETFs.

DWIN is a multi-asset portfolio that offers exposure to both the equity and fixed income markets – including investment grade and high yield bonds, fixed-rate preferred shares, dividend paying equities, US Treasuries, MLPs and real estate investment trusts (REITs). The portfolio can even convert to up to 80% US Treasuries in cases of extreme market turbulence – offering the potential for upside participation and downside risk mitigation.2 We believe DWIN is a compelling potential one-ticket rotation solution – tailor made for today’s low interest rate environment.

Learn more about the PowerShares DWA Tactical Multi-Asset Income Portfolio (DWIN).

1 Barclays US Aggregate Bond Index current yield: 2.37%. Source: Bloomberg L.P., March 7, 2016
2 Periodically, US Treasuries will rank highest in relative strength. In these cases, fewer than
five ETFs may be held, and the Treasury allocation can be up to 80% of the fund.

Important information

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

Barclays US Aggregate Bond Treasury Index tracks the performance of Treasury securities, government agency bonds, mortgage-backed bonds and corporate bonds.

JPM EMBI Global Index is an unmanaged index which tracks the total return of US dollar-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities.

S&P US Preferred Stock Index represents the US preferred stock market.

Wilshire US REIT Index measures US publicly traded Real Estate Investment Trusts (REITs).

Credit Suisse Leveraged Loan Index represents tradable, senior-secured, US dollar-denominated, non-investment grade loans.

Alerian MLP Index is a composite of the 50 most prominent energy master limited partnerships calculated by Standard & Poor’s, using a float-adjusted market capitalization methodology.

Barclays Municipal Bond Index is an unmanaged index considered representative of the tax-exempt municipal bond market.

Barclays US Corporate High Yield Index is an unmanaged index considered representative of fixed-rate, non-investment grade debt.

Barclays US Corporate Investment Grade Index is an unmanaged index considered representative of publicly issued, fixed-rate, nonconvertible, investment grade debt securities.

S&P 500® Dividend Aristocrats Index tracks the performance of 40 companies in the S&P 500® Index that have had an increase in dividends for 25 consecutive years.

DJ US Select Dividend Index represents the United States’ leading stocks by dividend yield, subject to screens for dividend-per-share growth rate, dividend payout ratio and average daily dollar trading volume.

There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund is subject to certain other risks. Please see the prospectus for more information regarding the risks associated with an investment in the fund.

Shares are not individually redeemable and owners of the shares may acquire those shares from the Fund and tender those shares for redemption to the Fund in Creation Unit aggregations only, typically consisting of 50,000 shares.

Beta is a measure of risk representing how a security is expected to respond to general market movements. Smart beta represents an alternative and selection index based methodology that may outperform a benchmark or reduce portfolio risk or both. Smart beta funds may underperform cap-weighted benchmarks and increase portfolio risk.

The momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that the returns on securities that have previously exhibited price momentum are less than returns on other styles of investing.

The Fund is subject to the risks of the underlying funds. Market fluctuations may change the target weightings in the underlying funds and certain factors may cause the Fund to withdraw its investments therein at a disadvantageous time.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, causing its instruments to decrease in value and lowering the issuer’s credit rating.

The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Most MLPs operate in the energy sector and are subject to risks relating to commodity pricing, supply and demand, depletion and exploration. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.

Preferred securities may be less liquid than many other securities, and in certain circumstances, an issuer of preferred securities may redeem the securities prior to a specified date.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and may be more volatile and less liquid.

The Fund is non-diversified and may experience greater volatility than a more diversified investment.

About Dorsey, Wright & Associates, LLC (DWA)

The relative strength strategy is not a guarantee. There may be times where all investment and strategies are unfavorable and depreciate in value. Investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisor and should not rely on the information herein as the primary basis for investment decisions. There is no relationship between Dorsey, Wright & Associates, LLC (“Dorsey Wright”) and Invesco PowerShares (“PowerShares”) other than a license by Dorsey Wright to PowerShares of certain Dorsey Wright trademarks, tradenames, investment models, and indexes (the “DWA IP”). DWA IP has been created and developed by Dorsey Wright without regard to and independently of PowerShares, and/or any prospective investor. The licensing of any DWA IP is not an offer to purchase or sell, or a solicitation of an offer to buy any securities. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. However, such information has not been verified by DWA or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein. DWA and the information provider accept no liability to the recipient whatsoever whether in contract, in tort, for negligence, or otherwise for any direct, indirect, consequential, or special loss of any kind arising out of the use of this document or its contents or of the recipient relying on any such recommendation or information (except insofar as any statutory liability cannot be excluded). PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC, investment adviser. Invesco PowerShares Capital Management LLC (Invesco PowerShares) and Invesco Distributors, Inc., ETF distributor, are indirect, wholly owned subsidiaries of Invesco Ltd.

Investors cannot invest directly in an index.  Indexes have no fees.  The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value.  Neither the information within this blog post, nor any opinion expressed, shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities, or exchange traded products.  This blog post does not purport to be a complete description of the securities or markets to which reference is made.  Each investor should carefully consider the investment objectives, risks and expenses of any Exchange-Traded Fund (“ETF”) prior to investing.  Before investing in an ETF investors should obtain and carefully read the relevant prospectus and documents the issuer has filed with the SEC.  ETFs may result in the layering of fees as ETF’s impose their own advisory and other fees.  To obtain more complete information about the product the documents are publicly available for free via EDGAR on the SEC website (http://www.sec.gov).

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