Fixed income exchange traded fund investors can consider an alternative solution to seeking income in this yield-challenged environment.
In the recent webcast, An Income-Focused Solution for a Yield-Challenged Environment, Kevin Flanagan, head of fixed income strategy at WisdomTree Asset Management, and Chris Acito, CEO and CIO of Gapstow Capital Partners, argued that investors and financial advisors are faced with the challenges of historically low interest rates and corporate bond spreads that have returned to pre-pandemic levels and do not offer as much in terms of relative value.
In today’s market environment, investors have to adapt to challenges to create a diversified income portfolio mix. Global interest rates remain near all-time lows. Credit spreads in U.S. corporate credit are near the lowest levels in recent history. Equity markets are near all-time highs despite uncertain outlooks for earnings. Traditional core-plus strategies may not meet investors’ current needs.
Investors will need to diversify away from the traditional stock and bond portfolio mix to meet these challenges. For example, the strategists highlighted alternative credit and developments in the free market that have helped democratize access to this asset category. Alternative credit is comprised of debt and debt-based securities with higher risk-return profiles than traditional investment grade bonds. Historically, these markets have primarily been limited to institutional or ultra-high net worth investors, typically through private fund structures. However, publicly traded alternative credit vehicles (PACs) offer an alternate way to access a wide range of alternative credit sectors on an intra-day basis.
For example, Gapstow Liquid Alternative Credit Index (GLACI) currently provides an income advantage of around 700bps compared to the benchmark 10-year U.S. Government Debt and nearly 2x the income potential of U.S. High Yield Corporates. Additionally, the asset category includes hybrid security exposure that exhibits characteristics of both equity and debt.
Specifically, publicly traded alternative credit vehicles (PACs) cover business development companies (BDCs), mortgage real estate investment trusts (REITs), and credit-centric closed-end funds (CEFs). PACs include BDC exposure through middle market corporate loans and venture debt. Agency mortgage-backed securities and non-agency that include mortgage-backed securities and whole loans make up the REITs component of PACs. Lastly, CEFs cover asset-backed securitizations, mortgage-backed securitizations, collateralized loan obligations, high-yield bonds, and leveraged loans.
The Gapstow Liquid Alternative Credit Index starts with a universe of BDCs, mREITs, and CEFs that trade for at least 90 days with an average trading volume above $750,000 over the past six months and an average market-cap of above $100 million over the last six months. The largest holdings in each sector are equally weighted, reconstituted on a semi-annual basis in April and October, and rebalanced quarterly.
GLACI consists of 35 constituents selected from the universe of 162 PACs, capturing 65% of the total PAC market capitalization. The index is equal-weighted to minimize concentration. PAC sub-sectors include private corporate lending, public corporate debt, commercial real estate lending, non-agency real estate debt, agency real estate debt, and multi-sector alternative credit. The index has an average 8.1% yield.
The index and the S&P 500 have had moderate correlation at around 0.65. GLACI and the ICE BofA Merrill Lynch U.S. High Yield Index has also been low at around 0.52. Lastly, the correlation between the GLACI and the Bloomberg U.S. Aggregate Index has been around -0.06.
“2020 was a challenging year for all asset classes, and many are just beginning to recover. We believe GLACI is poised to benefit from new interest rate regimes and market dynamics,” said the strategists.
“Alternative income can potentially provide equity-like total returns with significant amount of income — potentially more insulated from interest rate cycles,” they added.
The strategists advised investors to include alternative credit to complement existing fixed-income allocations, especially within their high-yield sleeves.
“We think a 10% position within fixed income allocations (4–6% of a portfolio with 40% fixed income) is prudent while also delivering attractive risk, return, and yield opportunities,” the strategists said. “A 5% position in alternative credit contributes about 20% of total portfolio yield.”
To access this yield opportunity, investors can look to the recently launched WisdomTree Alternative Income Fund (HYIN), which tracks the Gapstow Liquid Alternative Credit Index.
Financial advisors who are interested in learning more about income-focused investment solutions can watch the webcast on demand here.