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Rising rates uncover the sustainability of dividends for many companies. Previously, when rates were low, companies could easily borrow to buy back their stocks or pay dividends. Now, with the higher cost of borrowing, that’s over, and the focus shifts to owning companies with strong fundamentals — high-quality balance sheets, free cash flow yield — that can support a sustainable dividend structure.
Zero in on fundamentals
In today’s environment, investors not only may be able to take on less risk to generate the income they need, higher yields also provide them with “shock absorbers” against any future rate hikes.
Take comfort in a volatility buffer
Equities may still be necessary to meet long-term investment goals through growth, but higher yields mean investors may not need to take on as much equity risk to meet their income needs. Investors could consider dividend-paying equities, which may provide the opportunity for long-term growth and income, with less risk.
In the current environment investors should also take a closer look at how dividends are being generated. With the higher cost of borrowing, investors should consider identifying companies with a dividend structure supported by strong fundamentals rather than cheap borrowing.
Even beyond dividends, understanding a company's reliance on debt as part of their business model is of greater importance when rates (and thus borrowing costs) are higher. This argues for an active approach rooted in fundamental research versus a passive approach.
Focus on equity fundamentals
Does the current* 4% yield in short-term bonds mean that fixed-income portfolios should be composed entirely of these securities? We don't think so.
Investing in a portfolio of shorter duration bonds like U.S. Treasury bills and notes, or even money market funds, may deliver higher yield sooner. But there are opportunity costs to these investments — specifically the limited potential for price appreciation in your bond portfolio over the longer term. Depending on your time horizon, this may mean that you are missing out on a significant driver of total return. Bonds at the longer end of the yield curve may offer greater total return potential, especially if purchased at a discount to par.
Don't forgo (total) returns in bonds
Higher starting yields have important implications for fixed-income investors. Most immediately, they mean more income. Previously, an investor seeking a 4% yield had to invest in riskier high-yield bonds. Now, that yield can be achieved in less risky short-term U.S. Treasuries.
Income is easier to come by
The Fed hiked interest rates sharply in 2022 to combat high and sticky inflation.
The road to higher yields
“We have now stepped into a new world of positive interest rates. And the reality is that there are many investors today who have never lived in an environment with a real cost for borrowing money, which presents them with both challenges and opportunities. The challenge will be learning to differentiate the wheat from the chaff. But there’s also great opportunity for investors with the return of the income component — in nominal and real terms — across asset classes.”
The market value of securities may fall, fail to rise or fluctuate, sometimes rapidly and unpredictably. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. In general, equity securities tend to have greater price volatility than fixed income securities. Dividends are not guaranteed and the amount, if any, can vary over time. There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
Index descriptions:
Cash is represented by the 3-Month U.S. Treasury Bill.
Short-term Treasuries are represented by the Bloomberg U.S. Treasury 1-5 Yr Index, which measures the performance of U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury with remaining years to maturity between 1 and 5 years.
Long (20+ Yr) Treasuries are represented by the Bloomberg U.S. Treasury: 20+ Year Index, which measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index.
Investment Grade Corporates are represented by the Bloomberg U.S. Corporate Index, which measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
High Yield Corporates are represented by the Bloomberg U.S. Corporate High Yield Index, which measures the USD-denominated, high-yield, fixed-rate corporate bond market.
Emerging Market Debt is represented by the Bloomberg EM USD Aggregate Index, which is a flagship hard currency Emerging Markets debt benchmark that includes fixed and floating-rate U.S. dollar-denominated debt issued from sovereign, quasi-sovereign, and corporate EM issuers.
Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material, or guarantee the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, and shall not have any liability or responsibility for injury or damages arising in connection therewith.
Start here and then explore
Higher Yielding
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Rates are higher and income is back, but it's not a risk-free ride. We’ll help you get your bearings for the road ahead. Scroll down to learn more.
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Investing only in shorter duration bonds may deliver a higher yield now, but it also means missing out on a significant driver of total return.
Click to view chart
Income is easier to come by
Click to view chart
Don't forgo (total) returns in bonds
Click to view
Focus on equity fundamentals
As a result, yields also rose. Given the most recent and lengthy stretch of low yields, the current environment feels new and different — and it carries many considerations for investors.
Click to watch video
Take comfort in a volatility buffer
Click to watch video
Zero in on fundamentals
William F. "Ted" Truscott,
Chief Executive Officer
Fixed income
Fed funds rate (%)
Source: Federal Reserve
Interest rates have increased at a faster pace versus history
Yield (%)
Starting yields are the highest they've been in recent history
Bonds can provide income and capital appreciation
Click to view chart.
The road to higher yields
Higher yields change the relative appeal of asset classes and how investors should approach diversification.
Distinguishing between companies that are simply higher yielding and those that have a dividend structure for growth over time is important.
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Past performance is not a guarantee of future results.
Source: Bloomberg
See disclosure for information on the indices used to represent each asset class.
Past performance does not guarantee future results. It is not possible to invest directly in an index.
The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be appropriate for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that any forecasts are accurate.
Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.
Investment products offered through Columbia Management Investment Distributors, Inc., member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC.
© 2023 Columbia Management Investment Advisers, LLC. All rights reserved.
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Investing only in shorter duration bonds may deliver a higher yield now, but it also means missing out on a significant driver of total return.
Higher yields change the relative appeal of asset classes and how investors should approach diversification.
*As of 12/30/22
