Investigating Unique Income Options

On a percentage, 2023 S&P 500 dividend growth likely won’t mirror 2022 levels, but it’s also likely to hit all-time highs in dollar terms. That’s good news for income-needy clients.

In the first quarter, S&P 500 payouts jumped 8% -- an impressive clip to be sure – while share repurchases declined 21% year-over-year, indicating that at least for now, companies prefer cash distributions to buying back their own stock.

“The difference in outlooks for dividend and buyback growth suggests firms focusing on dividends will continue to outperform buyback stocks,” wrote Goldman Sachs chief U.S. equity strategist David Kostin in a recent report.

Rising equity income is a positive for advisors and clients alike, but as advisors know, there’s more to the income game than common stocks and bonds. Fortunately, the time appears to be right to consider some unique yield-generating asset classes.

Call on Convertibles, Preference for Preferred Stocks

Two hybrid asset classes – convertible bonds and preferred stocks – look appealing in the current market environment.

“Convertibles not only pay interest, they also reduce some of the potential drawbacks of both stocks and longer-duration bonds,” according to Fidelity. “Convertible bonds generally are less sensitive than high-yield or other bonds to the risks that changes in interest rates may pose. Convertible prices can fall if interest rates rise and stock prices decline, but they are less sensitive to such changes than both stocks and traditional corporate bonds.”

While convertible bonds are among the fixed income assets least correlated to rising interest rates, preferred stocks are at the other end of the spectrum. Preferreds, which have equity and fixed income traits, are highly correlated to Treasury yield gyrations, making the asset class potentially ideal for when the Federal Reserve signals it’d done hiking borrowing costs.

Adam Kramer, manager of the Fidelity® Multi-Asset Income Fund (FMSDX), sees opportunity in bank preferreds following March’s calamity in the space. Banks are the biggest issuers of preferred stocks and they must pay the dividends on those issues or risk credit downgrades.

"Fixed-to-floating rate preferred stocks of large banks have offered yields 3 to 4 times higher than the dividends paid on the banks' common stock," he says. "As regulation increases, interest rates move lower, and the economy slows, bank earnings and dividends may be lower in the future. Meanwhile, investment-grade fixed-to-floating preferreds have been trading below their face value while also offering up to 4 times more income than those banks' dividends offer. They also offer additional upside to par when their interest rates begin to float in 1 to 3 years.”

A Golden Income Idea

Gold is one of this year’s best-performing assets, but in either physical or exchange traded fund form, it doesn’t lob off income.

However, some large-cap gold mining stocks do and that group’s balance sheet have materially improved in recent years, leading to a spate of shareholder rewards initiatives. With gold demand supported by inflation and central bank buying, miners could be a credible income destination for risk tolerant clients.

“Gold has long been popular with investors who are concerned about the power of inflation to reduce the value of cash and other investments, but owning it also comes with risks,” concludes Fidelity. “Gold miners' earnings have historically grown when demand has risen, as it often has in times when economic growth has been weak and real yields decline along with interest rates. Gold miners typically distribute a significant portion of those earnings to shareholders in the form of dividends.”

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