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Fixed-Income Insights

video

Zane Brown explains why short-duration high-yield municipal bonds, short duration credit, and dividend-paying stocks are appealing for investors in times of subzero interest rates.

Transcript

Video: Three Income Strategies for a Negative-Rate World:€“ Transcript

Welcome to Lord Abbett'€™s Investment Perspectives

Three Income Strategies for a Negative-Rate World

Zane Brown, Partner and Fixed-Income Strategist

Zane Brown: The past several years, it's been difficult to find investments with attractive yield. After Brexit it's even more difficult. Global investors have bid up the price of high quality fixed income securities almost everywhere.

If we look at different investments from a variety of countries, we find that negative yields are not the exception but oftentimes the rule. Now, there are some options to find positive yield but oftentimes you end up finding longer maturities and taking on that maturity or price risk in order to capture a positive yield. On closer examination, even those yields are not that attractive.

Interestingly, though, looking at the United States, we find that here is one country where there are positive yields from two years all the way up to 30. But even we know that the 10-year yield, at 1.4/1.5% is barely enough to cover inflation and falls short of the Fed's longer-term target for inflation of 2-percent or more.

GRAPHIC:
GOVERNMENT DEBT IN MANY NATIONS FEATURES BELOW-ZERO YIELDS YIELDS (IN PERCENT) ON VARIOUS MATURITIES OF DEVELOPED-NATION GOVERNMENT BONDS, AS OF JUNE 30, 2016
Source: Bloomberg and U.S. Treasury Department. Data are as of June 30, 2016. Past performance is no guarantee of future results.

Zane Brown: So it's time to find alternatives. We've talked in the past about high yield as an asset class being an effective alternative in this environment. But there are other asset classes that may appeal to a broader contingent of investors.

Short-Duration, High Yield Municipal Bonds

Zane Brown: One of those asset classes is municipals and short-term high yield municipals may be a consideration for some investors. By looking at the municipal market we can stay away from the fray and the consequences of what's going on elsewhere in the world.

We find that in the municipal market there is very little effect of the change in currency evaluations, the uncertainty associated with emerging markets, and the declining value of a lot of commodities. The municipal asset class is clearly focused on the United States.

By tilting maturities more towards the shorter end we can put together a portfolio that has less volatility than is normally associated with longer-term municipals. By focusing on the high-yield aspect of municipal bonds we can put together a relatively attractive yield especially for those investors who are at or close to the marginal tax bracket. And we find that this asset class has a low correlation to other fixed income asset classes so, you know, collectively it may be an interesting alternative for a lot of investors to include in their broader portfolio.

Short-Duration Credit Securities

Zane Brown: A second consideration may be short duration credit securities. Here we're putting together a portfolio that tries to capture high yield, but is a shorter or lower duration core bond strategy. And doing that by approaching the short-term end with a flexible multi-sector approach that takes advantage of different kinds of securities with shorter maturities, putting together a portfolio that has higher yield than you'd normally associate with a low duration portfolio and less volatility than you associate with most core strategies.

High-Quality Dividend-Paying Stocks

Zane Brown: So short duration high yield, short duration credit are two alternatives. A third alternative is dividend-paying stocks. Now here I'd say high-quality dividend-paying stocks. Because if you just pursued the highest dividend paying stocks, historically that's not been an effective strategy. But putting together dividend paying stocks that capture a dividend yield today that is in excess of what you can capture in the 10-year Treasury of 1.4 or 1.5-percent may be an interesting option for some investors.

Historically we know that dividend-paying stocks have offered greater return and less volatility than the broader market. So this, too, may be part of a broader income strategy.

Zane Brown: So these three strategies, these three income strategies, short-duration high-yield municipal, short-duration credit securities, and dividend-paying stocks may be one or three parts of an income producing strategy that may fit a variety of investors and at least allow some positive steps in a negative yielding world.

This has been Lord Abbett's Investment Perspectives. Thank you for watching.

Learn more at lordabbett.com

VIDEO DISCLOSURE

For all charts presented herein: The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

Past performance is no guarantee of future results.

Glossary

Correlationis a statistical measure that indicates how closely two entities (e.g., securities, indexes, or portfolios) move in relation to each other. A correlation of 1.0 indicates that a move up or down by one is matched by a move in the same direction by the other. A correlation of -1.0 indicates that a move up or down will be matched by move in the opposite direction. A correlation of 0.0 indicates that the two entities have no statistical relationship.

Dividend policy: A stock is classified as a dividend payer if it paid a cash dividend any time during the previous 12 months, a dividend grower if it initiated or raised its cash dividend at any time during the previous 12 months, and non-dividend payer if it did not pay a cash dividend at any time during the previous 12 months.

Duration is the change in the value of a fixed-income security that will result from a 1% change in market interest rates. Generally, the larger a portfolio’s duration, the greater the interest-rate risk or reward for underlying bond prices.

Yield is the annual interest received from a bond and is typically expressed as a percentage of the bond's market price.

Quality stocks: Equities with a track record of earnings and dividend growth are often characterized as high-quality. For example, independent research firm Standard & Poor’s assigns quality rankings to stocks on their 10-year history of earnings and dividend growth.

Risks to Consider

The value of investments in debt securities will fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. High-yield securities carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. High-yield municipal bonds with shorter maturities and durations carry heightened credit risk, liquidity risk and potential for default. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Puerto Rico and other U.S. territories, commonwealths, and possessions, may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems. No investing strategy can overcome all market volatility or guarantee future results.

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

This broadcast serves as reference material for information purposes only; does not constitute an offer to acquire, solicitation for an offer to acquire, an offer to sell or solicitation for an offer to buy, any securities, nor is intended to be relied upon as a forecast, research, or investment advice on any securities, and cannot be used for any of the foregoing.

The views and opinions expressed by the Lord Abbett speaker are those of the speaker as of the date of the broadcast, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions and Lord Abbett disclaims any responsibility to update such views. Neither Lord Abbett nor the Lord Abbett speaker can be responsible for any direct or incidental loss incurred by applying any of the information offered.

This broadcast is the copyright© 2016 of Lord, Abbett & Co. LLC. All Rights Reserved. This recording may not be reproduced in whole or in part or any form without the permission of Lord Abbett.

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