Managers of income strategies are faced with the dilemma of all-time low bond yields and dividend paying stocks exhibiting significant volatility. The questions these circumstances raise are: Do managers reduce income targets? Or take on more risk in search of yield? The answer may be neither, as this brief report explores.
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How Factor ETFs Can Help Achieve Target Income
Utilizing factors such as quality, minimum volatility, and value alongside existing equity/bond positions could help managers of income strategies maintain target income levels while seeking improved resilience.
Here’s how:
Deeper Look
“Using a factor lens for an income portfolio may help reduce the ‘yield traps’ that can hurt the equity income investor. For example, some high yield stocks may have unsustainable payouts and high volatility. Considering the quality characteristics of a stock based on its fundamentals may help reduce volatility and ensure a sustainable payout. To this end we often find institutional and wealth investors include quality and minimum volatility factors to complement the income portfolio.”
– Mark Carver, Managing Director, Global Head of Equity Factors, MSCI
“In the multi-asset space, we see two approaches – investors who have largely built their portfolios stock by stock and bond by bond, and others who use managed solutions run by their larger organization. If you’re someone who builds portfolios using individual securities, factors play a role, but you’re not necessarily always considering what factor exposures arise as a by-product of your stock selection. In that case, we can help clients form a view on momentum or increased volatility. We can show them how to potentially lower their overall volatility exposure with an ETF that gives them market-like exposure without requiring them to decide on which stocks they need to buy and sell.”
– Del Stafford, Head of iShares Portfolio Consulting, BlackRock
1 As of 12/31/19
Here’s how:
- Consider allocating to equity and bond factor ETFs with the goal of diversifying some of the unique risks associated with today’s income-seeking strategies. These can include specific sector/factor biases and idiosyncratic risks.
- BlackRock can provide customized portfolio consulting, including risk analysis, for institutional investors.
- Using a proprietary risk model, analysis of the peer group’s equity style factor exposures (see Figure 1, below) showed strong exposure to high dividend-yielding stocks, but at the cost of higher leverage and lower profitability – a negative quality bias which could drag on return. The average fund also exhibited meaningful smaller-cap, value, and anti-growth tilts.
- The average fund also showed large overweights to the real estate, energy, and utilities sectors (see Figure 2, below). These sectors have historically paid an attractive dividend yield but can exhibit increased sensitivity to interest rate changes and fluctuations in energy supply and demand.
- Equity dividend ETFs (i.e., iShares Core High Dividend ETF [HDV], iShares Select Dividend ETF [DVY], iShares International Select Dividend ETF [IDV]) tend to exhibit similar directional factor exposures (see Figure 3, below).
Deeper Look
“Using a factor lens for an income portfolio may help reduce the ‘yield traps’ that can hurt the equity income investor. For example, some high yield stocks may have unsustainable payouts and high volatility. Considering the quality characteristics of a stock based on its fundamentals may help reduce volatility and ensure a sustainable payout. To this end we often find institutional and wealth investors include quality and minimum volatility factors to complement the income portfolio.”
– Mark Carver, Managing Director, Global Head of Equity Factors, MSCI
“In the multi-asset space, we see two approaches – investors who have largely built their portfolios stock by stock and bond by bond, and others who use managed solutions run by their larger organization. If you’re someone who builds portfolios using individual securities, factors play a role, but you’re not necessarily always considering what factor exposures arise as a by-product of your stock selection. In that case, we can help clients form a view on momentum or increased volatility. We can show them how to potentially lower their overall volatility exposure with an ETF that gives them market-like exposure without requiring them to decide on which stocks they need to buy and sell.”
– Del Stafford, Head of iShares Portfolio Consulting, BlackRock
1 As of 12/31/19
