The Fed has finally drawn its line in the sand: inflation has gotten intolerable and interest rates need to start tightening in order to fight it. While this is less of a realignment of policy than a shuffle of priorities, it's still nice to see, notes Todd Shaver, editor of Bull Market Report.
Of course, everything revolves around the details and the execution, but it currently looks like the first tentative step back to a pre-COVID rate environment could come as early as March or April, opening a path for another two or even three small tightening moves before the end of 2022.
We've taken some time recently to reset our high yield guidance, starting with stocks and funds that will pay positive returns in a "normal" inflation environment (2-3%) and then shifting up the risk-return scale to opportunities to lock in much more robust income streams.
This time around, we'd simply like to highlight a few of our favorite high yield recommendations. They don't necessarily have the highest yields or the lowest risk profiles, but each in its way hits a "sweet spot" in our view.
One is complex but has proven surprisingly reliable in its cash flow. Another focuses on assets that shield investors from tax. If you're worried about taxes in the coming year, now is the time to capture funds like this and lock in their tax-free income.
PIMCO Dynamic Income Fund (PDI) yields 10.4%. The fund invests across a wide range of fixed income securities, including sovereign debt, high-yield corporate bonds, mortgage-backed securities, and derivative instruments, with varying coupon rates, maturities and credit quality, with the aim of generating income and appreciation, while also focusing on capital preservation.
The fund’s exposure to corporate credit played a key role in its performance during the quarter, with strong corporate earnings and economic indicators driving demand. Exposure to residential mortgage credit and asset-backed securities were the second and third largest contributors, respectively, with the broader economic recovery, and resilient demand for housing being key factors.
Emerging market debt and special situation investments were main detractors during the quarter, mainly owing to the appreciation of the US dollar against other currencies, and the rise in local rates with uneven recoveries, and the resurging virus playing spoilsport. Select investments of the fund posted negative returns during the quarter.
PIMCO continues to strive to generate risk-adjusted returns for investors, with a focus on non-agency mortgage-backed securities, purchased at discounts with low loan-to-value ratios.
This fund remains perfect for income investors who also seek capital preservation. With a diversified portfolio, actively managed by an experienced team, and an expense ratio at 2.8%, this fund remains a mainstay in our portfolio.
Invesco Municipal Trust (VKQ) yields 4.5% tax free or the equivalent of 7.0% taxable. The fund invests in a diversified portfolio of US municipal bonds to generate secure tax-free income for investors while ensuring capital preservation and striving to generate risk-adjusted returns. This is great for conservative investors looking for steady cash flows, with no volatility or risks for their capital.
The municipal bond market remains as strong as ever, despite the shutdowns and loss of revenues that many cities and towns experienced over the past few years. The aid and relief programs, along with the Municipal Liquidity Facility by the Federal Reserve continue to sustain confidence in investors, who view municipal debt as a strong alternative to overvalued equity markets.
The default rate among municipal bonds is incredibly low, at $2.2 billion or just 0.05% of the $3.9 trillion markets in 2020. These defaults are usually concentrated in the high-yield sectors. The company employs leverage to increase returns, and while this can intensify downside risks, they again don’t affect long-term investors.
The Invesco Municipal Trust remains as sturdy as ever, despite losses in the beginning of 2020, it recovered quickly, and now stands to gain from the stimulus and infrastructure bills that will aid cities across the US. Irrespective of what new twists we can expect from the pandemic or the global economy, The Muni Trust will continue generating above-average returns.