Generating sufficient amounts of income is a challenge in a low-interest-rate environment, says Brian Katz, the chief investment officer of The Colony Group.
"During the recent prolonged stretch of low interest rates, many advisers have used higher yielding surrogates in place of traditional fixed-income investments, such as bonds, in an attempt to source higher yields," he says.
And in so doing, they may have taken unintended risks. Examples of investments that investors have migrated towards in place of bonds include, Katz says, are REITs, MLPs, business development corporations (BDCs), and high-yielding stocks.
"Most of these exhibit much higher volatility than traditional fixed-income investments and have a higher chance of permanent capital loss," he says. "They have also proven to be just as, if not more, sensitive to interest rates during this year's rise in the 10- year Treasury yield."
By contrast, Katz and his team at The Colony Group have endeavored to find higher yielding investments with similar risk profiles to more traditional fixed-income securities.
"Senior loans, for example, are less sensitive to rising rates because the yield is generally floating," he says. "It should be noted, however, that these securities carry higher credit risk than their investment grade corporate bond counterparts."
But if the global economy remains strong moving forward, these securities should provide solid returns without too much risk, says Katz.
One example: PowerShares Senior Loan ETF (BKLN) .
Private Market Credit
Katz and his team have also recently allocated to private market credit. "The effectiveness of these investments depends on the general partners' skill at underwriting credit or appropriately valuing bonds purchased in the secondary market," he says.
Lastly, they have sourced alternative forms of fixed-income investments. "Marketplace lenders, commonly referred to as peer-to-peer lending, have the potential to generate higher yields without incurring incremental risk by disintermediating banks," he says.
"They have filled a void between banks and credit card companies, offering borrowers lower yields combined with a hassle-free underwriting process."
And for investors, Katz says P2P lending can offer higher yields with a different take on credit risk than corporate bonds. "Investors, however, should take caution to properly diversify across borrowers, geographies, and loan types when allocating to this segment," he says.
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