Yield enhancers

We have been in favour of strategies that look to improve total return with yields since April 2019. Considering that we expect price returns to be fairly muted in 2020 across major asset classes, we would continue to look for enhancing total returns with yields.

Prefer safer yields over higher ones

There are several options to capture some yields. First of all, in equities, we have a preference for dividend growers. Companies growing their dividends tend to do better than high-dividend companies.

We would be cautious of buying companies based solely on the dividend yield. A disproportionally high dividend yield often reflects the market expecting that the company will cut its dividend at some point. By contrast, we think that either focusing on companies that are growing dividends or on companies with stable cash flows that have the financial strength to pay their dividends is a better strategy in equities.

In fixed income, we see the best risk/return reward from a yield perspective in emerging market (EM) debt. As with equities, we would not chase the highest yield. Considering the late stage of the economic cycle, we think it is too risky to sacrifice strength to chase higher coupon in the junk bond part of the market. On the corporate side, we see opportunities to pick up yield in BBB-rated bonds, especially when extending duration.

Spreads are already tight in the high yield space and we see little room for improvement. On the contrary, we expect EM economies to improve slightly in 2020 compared with 2019. Furthermore, we see opportunities for EM fixed income to add yields in a portfolio while mitigating risks of a large increase in spreads.

Volatility provides good opportunity for yield enhancement

Volatility is one area where we see good opportunities for total return enhancement. Rising uncertainties are likely to translate to higher premium for insurance against a market sell-off. This is a good time to set up strategies that consistently aim to extract this higher premium from the market.

In order to be effective and relatively safe, those strategies collecting premium should be systematic and focused on collecting short-dated premium. A short-term contract provides the opportunity to renegotiate the premiums more frequently, allowing potentially higher premium income.

And doing it systematically can capture spikes in volatility without worrying about timing. It also reduces the risk of being caught wrong-footed with the timing for selling volatility. When done properly, a volatility-selling strategy should add positive performance to a portfolio.

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