Multi-Asset Income Investing

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1 LEADERSHIP SERIES Multi-Asset Income Investing Look for go-anywhere flexibility focused on income and guided by a risk framework Adam Kramer l Portfolio Manager Jim Morrow l Portfolio Manager Ford O Neil l Portfolio Manager Lisa Kasparian l Institutional Portfolio Manager Key Takeaways A multi-asset income fund can be a core solution for income and capital appreciation within an investor s asset allocation. Income-oriented, multi-asset funds can benefit from having the flexibility to invest across asset classes, sectors, and securities without benchmark constraints. Tactical management of a multi-asset income fund should incorporate nimble asset allocation and agile security selection. In a multi-asset income fund with a go-anywhere investment flexibility, it is judicious for it to have defined and quantifiable risk-control parameters. According to a 2014 investor survey, the most important financial goals among households are to ensure a comfortable standard of living in retirement, and to protect current levels of wealth. 1 These sentiments, and years of low interest rates, may help explain why investors have been drawn to multi-asset income strategies that combine income-producing equities and fixed income for capital appreciation, income, and stability. Maybe investors are more comfortable with professionals making the asset allocation decisions especially when markets can be volatile. Since December 2011, there have been 16 multi-asset funds launched across three categories: conservative-, tactical-, and world-allocation funds, which totaled $2.5 billion in assets at the end of June Many funds in this category rely on a go-anywhere strategy to deliver on their income objective. An unconstrained approach makes sense from an investment perspective, because it can benefit from diverse sources of income and capital appreciation

2 across a broad group of income-oriented asset classes stocks, convertibles, preferred securities, bank loans, high-yield bonds, investment-grade bonds, and emerging-market debt (more on this topic later). The benefits of a go-anywhere strategy can be enhanced when the portfolio is managed within a defined riskcontrolled framework one that incorporates clear parameters for how the manager thinks about risk. In this paper, we outline important elements to consider when choosing a go-anywhere multi-asset income fund: Investment flexibility across income-producing asset classes Tactical management of asset allocation and security selection A risk-management framework that guides unconstrained investing Flexibility to exploit global opportunities To meet its goal of combining attractive income and riskadjusted returns, an income-oriented multi-asset fund should have the latitude to invest across asset classes, sectors, and securities, without being constrained by benchmark holdings. Consider the dispersion of annual returns across asset classes (see Exhibit 1). An incomeproducing asset class has outperformed equities (as defined by the S&P 500 Index) and investment-grade bonds (as defined by the Barclays U.S. Aggregate Index) in 11 of the past 16 periods. During this time, the narrower exposures of single-asset-class investors, or investors in a traditional balanced portfolio of 50% stocks and 50% bonds, may have also had narrower upside potential. By having the opportunity to invest across a full spectrum of income-oriented assets, funds have the potential to EXHIBIT 1: Annual asset class returns Single-asset-class investing may leave investors missing opportunities Best 1-Year Return Worst 1-Year Return ASSET CLASS YTD 6/15 Investment-Grade Bonds Emerging-Market Debt Floating-Rate Debt High-Yield Bonds Convertible Securities Preferred Securities Equities Dispersion of Returns Source: Fidelity Investments, as of June 30, Indexes: Investment-grade bonds Barclays U.S. Aggregate Bond Index. Emerging-market debt JPMorgan EMBIG Index. Floating-rate debt S&P Performing Loan Index. High-yield bonds BofA Merrill Lynch U.S. High Yield Constrained Index. Convertible securities BofA ML All U.S. Convertibles Index. Preferred shares BofA Merrill Lynch Fixed Rate Preferred Securities. Equities S&P 500 Index. 2

3 MULTI-ASSET INCOME INVESTING exploit compelling investments across global markets, and to maximize income and capital appreciation prospects for shareholders. For example, 2002 was a down year for the stock market, and as one might expect, investment-grade bonds provided a strong diversification benefit by returning 10.3%. However, it was another diversifying asset class that generated the best performance across income-oriented asset classes emerging-market debt was up 13.1%. Stressing nimble allocation and agile security selection through tactical management While many multi-asset income funds use a tactical investment approach focused on asset allocation and security selection, they often restrain its effectiveness by managing a portfolio with too many securities and therefore overdiversifying. Such an encumbered portfolio makes it nearly impossible to adjust positioning in a timely way or for security selection to generate meaningful alpha (relative to a balanced portfolio of 50% stocks and 50% bonds). Advisors should look for a fund that balances asset class exposures and security-specific risks. This approach can provide two advantages: (1) the appropriate level of diversification to help the fund meet its income-oriented investment objective and (2) enhanced potential for an investment team s best researchdriven ideas to influence performance. EXHIBIT 2: Asset classes pose spectrum of risks Successfully determining risk-and-return prospects across income-oriented sectors requires experienced portfolio management, research, and trading Floating-Rate Debt Emerging Market Debt Corporate Bonds Government Bonds High-Yield Bonds Convertible Bonds Preferred Securities Dividend-Paying Stocks TIPS Yield REITs Cash S&P 0 Equity Market Sensitivity (Beta) Duration Credit Equity 1 For illustrative purposes only. The chart above depicts general long-term directional and ranking relationships among a number of asset classes on the dimensions of yield and beta. Beta is estimated in comparison with U.S. common stocks as represented by the S&P 500 Index. The relationships and relative rankings among these asset classes will vary over time. 3

4 Resources to uncover opportunities Asset valuations are constantly being determined by investors who are weighing three key risks: equity risk, interest-rate risk, and credit risk (see Exhibit 2, page 3). When the market does not accurately price these risks, investment opportunities can arise. Often, these occasions can be short-lived; so a portfolio manager must be able to nimbly take advantage of them. Consider, for example, the movement in credit spreads for fixed-rate preferred securities relative to that of investment-grade bonds in In anticipation of a Federal Reserve interest-rate increase, yield spreads widened as that summer began. As the market determined the interest-rate risk associated with preferred securities, the spread between fixed-rate preferred stocks and investment-grade bonds widened to historically high levels. Such junctures in the market can present opportunities for deft portfolio managers to draw on insightful research. In this case, a manager not only had to recognize that preferred securities were being undervalued due to an overestimation of interest-rate risk, he or she also needed research analysis to discern which individual preferred securities presented the best prospects. As it turned out, preferred securities were the highest-returning income asset class in Given the breadth of income-oriented asset classes, consistently and accurately identifying opportunities in the market can be a daunting challenge. Such a process requires a portfolio manager to be supported by broad and deep research and trading resources that can constantly elevate the best ideas across market segments. These teams can provide a steady stream of insights and data for a portfolio manager to determine whether an opportunity presents a favorable risk and return equation one with more upside potential versus downside potential. Marrying go-anywhere management with risk controls Being untethered by a benchmark s positioning, portfolio managers can invest across asset classes in search of securities with credible income properties and the potential for compelling total returns. This freedom to go anywhere can unnerve investors who are used to having a benchmark to gauge fund management and performance. This is understandable and why, as part of their due diligence, advisors should determine how aggressive or volatile a multi-asset income fund is likely to be. In lieu of a stated benchmark, a portfolio manager should be able to define and quantify the risk-control parameters that influence his or her decision making. For example, how sensitive will the fund be to interest-rate change? How correlated will the fund be with the stock market? How far down in credit quality will the manager reach to maximize income? Advisors and investors should have the comfort of knowing a manager won t reach for income or capital appreciation without being mindful of the associated risks. Advisors and investors should look for an investment process that includes ongoing monitoring and assessments of equity, interest-rate, and credit risks, and a defined process for budgeting portfolio risks along these dimensions. A risk-management process should be in place that leads to enhanced risk-adjusted return potential, including capital preservation through full investment cycles. Differentiating multi-asset income funds As advisors and investors seek a dependable core solution for income and capital appreciation, they should consider the following questions as a way to differentiate multi-asset income funds: 4

5 MULTI-ASSET INCOME INVESTING How does the manager measure success? Is the fund overdiversified? Can asset allocation and security selection generate alpha? Is the manager s investment process disciplined and repeatable? What is the manager s definition of risk? Is the management team experienced investing in the universe of income-oriented sectors? How deep are the resources supporting the portfolio manager? Analyzing a fund from these perspectives will uncover funds where a portfolio manager can effectively play offense (generating capital appreciation and income through flexible and tactical asset allocation and security selection) and defense (producing income from higher-yielding securities that help tamp volatility and preserve capital). This combination within a risk-controlled framework can translate into an attractive investment that complements an existing asset allocation. Authors Adam Kramer l Portfolio Manager Adam Kramer is a portfolio manager in Fidelity s High Income division. In this role, he manages Fidelity Advisor Multi-Asset Income Fund and Fidelity Tactical High Income Fund (a multi-asset income strategy offered to the Canadian marketplace). He also manages the concentrated high-yield and convertible subportfolios of Fidelity Equity-Income Fund, VIP Equity-Income Fund, Fidelity Advisor Equity Income Fund, and the straight preferred stock subportfolio and the convertible subportfolio of Fidelity Strategic Dividend & Income Fund. In addition, Adam manages the convertible securities portion of Fidelity U.S. Dividend Fund available to Canadian investors and an opportunistic high-yield bond strategy for an institutional portfolio available to U.S. investors. Prior to assuming his current responsibilities, Adam worked as a portfolio assistant on Fidelity Leveraged Company Stock Fund, Fidelity Convertible Securities Fund, and Fidelity Advisor High Income Advantage Fund starting in He began working at Fidelity in 2000 as a research analyst and has since covered a variety of industries. Jim Morrow l Portfolio Manager Jim Morrow is a portfolio manager in Fidelity s Equity division. In this role, Jim manages Fidelity Series Equity-Income Fund, Fidelity Advisor Series Equity-Income Fund, Fidelity Advisor Diversified Stock Fund, and Fidelity Advisor Multi-Asset Income Fund. He also serves as lead manager of Fidelity Equity-Income Fund, Fidelity Advisor Equity Income Fund, and VIP Equity-Income Portfolio. Jim joined Fidelity full time as an equity research analyst following the broadcasting and wireless towers industries in Before serving as an equity research summer intern with Fidelity in Ford O Neil l Portfolio Manager Ford O Neil is a portfolio manager in the Fixed Income division at Fidelity Investments. In this role, Ford manages various taxable bond portfolios, including Total Bond Fund, Total Bond ETF, Strategic Real Return Fund, Strategic Income, Strategic Dividend & Income, Intermediate Bond Fund, Balanced Fund, and Fidelity Advisor Multi-Asset Income Fund. Prior to assuming his current position in August 1992, Ford worked as an analyst in Asset Management focusing on the electric utility sector from 1990 to He joined Fidelity in Lisa Kasparian l Institutional Portfolio Manager Lisa Kasparian is an institutional portfolio manager in Fidelity s High Income division. In this role, Lisa serves as a member of the investment management team, maintaining a deep knowledge of portfolio philosophy, process, and construction, assisting portfolio managers and their CIOs in ensuring portfolios are managed in accordance with client expectations, and contributing to investment thought leadership in support of the team. She is also a principal liaison for portfolio management to a broad range of current and prospective clients and internal partners, providing detailed portfolio reviews and serving as a key conduit of client objectives, requirements, and marketplace insight back to the investment team. Fidelity Thought Leadership Vice President Geri Sheehan, CFA, provided editorial direction for this article. 5

6 Endnotes 1 Cerulli Associates, The Cerulli Report: U.S. Retail Investor Products and Platforms 2014: Matching Product and Distribution Strategy to Client Demands (41% of households surveyed rated ensure a comfortable standard of living in retirement as their number one goal, and 26% rated protect current level of wealth as their number one goal. 2 Source: Morningstar. Before investing, consider the funds investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. Unless otherwise disclosed to you, in providing this information, Fidelity is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with any investment or transaction described herein. Fiduciaries are solely responsible for exercising independent judgment in evaluating any transaction(s) and are assumed to be capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. Fidelity has a financial interest in any transaction(s) that fiduciaries, and if applicable, their clients, may enter into involving Fidelity s products or services. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information. Investment decisions should be based on an individual s own goals, time horizon, and tolerance for risk. Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for investments that focus on a single country or region. In general the bond market is volatile, and fixed-income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed-income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. High-yield/ non-investment-grade bonds involve greater price volatility and risk of default than investment-grade bonds. Investing involves risk, including risk of loss. Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. All indices are unmanaged. You cannot invest directly in an index. Indexes Barclays U.S. Aggregate Bond Index is a broad-based, market-valueweighted benchmark that measures the performance of the investment-grade, U.S. dollardenominated, fixed-rate taxable bond market. JPMorgan EMBIG Index is an index of U.S. dollar-denominated debt instruments issued by Emerging Market sovereign and quasi-sovereign entities, such as Brady bonds, loans, and Eurobonds. S&P Performing Loan Index measures the performance of U.S. dollardenominated senior-secured term loans, including non-investment grade and non-rated loans. BofA Merrill Lynch U.S. High Yield Constrained Index is a market capitalization-weighted index of U.S. dollar denominated below investment-grade corporate debt publicly issued in the U.S. domestic market. It contains all securities in The BofA Merrill Lynch US High Yield Index but caps issuer exposure at 2%. BofA ML All U.S. Convertibles Index measures the performance of U.S. dollardenominated convertible securities not currently in bankruptcy with a total market value greater than $50 million at issuance. BofA Merrill Lynch Fixed Rate Preferred Securities Index measures the total return of a diversified group of investment-grade preferred securities. S&P 500 Index is a market capitalizationweighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. 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