Multi-asset income funds have increased their exposure to higher quality bonds, according to research from Morningstar.
As diversification between equities and bonds failed in 2022, Morningstar’s latest research looking at the landscape for multi-asset income funds found within fixed income allocations managers have increased their investment grade exposure and decreased their high yield weightings since the start of last year.
According to Morningstar, this reversed a previous downtrend from 2020 to 2021 when central banks’ rate cuts amidst the coronavirus outbreak had compressed bond yields to historical lows and forced managers to take more risk through higher-yielding securities, such as high-yield credits, to maintain their payouts at a competitive level.
This shift is set against a background in which the classic 60% stocks/40% bonds balanced portfolio suffered from one of its worst years in history, as highlighted by the 17.7% decline of the Morningstar Global 60/40 Index (in dollar terms).
“With looming recession risk and elevated market volatility, income seekers are attracted to lower-risk products that offer attractive yields without taking on meaningful investment risks, such as bank deposits and money market funds,” says Bryan Cheung, associate director at Morningstar.
“However, we would caution investors on their trade-offs, particularly reinvestment risk and the lack of capital growth in cash and money market investments,” he adds.
This warning comes as Morningstar reports that globally over the past year ended April 2023, bank deposits and money market funds have eclipsed other fund categories with $771bn (£609bn, €708bn) in net inflows, compared with net outflows $539bn from equity funds and $447bn outflows from fixed income funds.
Instead, in what Cheung described as “normalised” interest rate environment, he says multi-asset income funds provide investors a more “attractive opportunity set”.
“With an improved outlook on fixed income assets and the diversification benefits these assets bring, investors in multi-asset income funds can benefit from an improved pay-out without their managers needing to take on excessive risks,” he said.
“Investors should be mindful of the cyclicality of interest rates and the higher reinvestment risk inherent in short-dated defensive assets and meanwhile should not forget the importance of balancing between yields and risks to generate more consistent income and capital growth over time.”