Morningstar: Positive Fixed Income Outlook Boosts Relevance Of Income Multi-asset Funds

Bryan Cheung, associate director, and Tom Mills, senior analyst at Morningstar Research, urged managers to look at mitigating risks in a changing market environment and make the most of their fixed income allocation to attract income investors.

After the pandemic caused a decline in capital and income and the large sell-off in 2022 eroded multi-asset funds' long-term returns, the firm said there had been a trend towards higher distribution yield and bond allocation.

There had also been a "gradual shift" to higher quality bonds with an increase in investment-grade exposure and a decline in high-yield exposure, the analysts added. 

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Morningstar Research said that considering the current economic backdrop, multi-asset managers have "multiple levers to pull to balance risk and return", including high-quality duration, investment-grade bonds and cash, while earning better yields.

Cheung and Mills said: "With elevated market volatility and increasing risk of recession, income seekers are attracted to lower-risk products that offer attractive yields, such as bank deposits and money market funds.

"However, we would caution investors on their trade-offs, particularly reinvestment risk and the lack of capital growth in cash and money market investments."

Despite this, they highlighted multi-asset funds have an opportunity to "remain relevant" as they still have a role to play in income investors' portfolios, if they are "willing to look beyond the near-term uncertainties".

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They said investors should be mindful of the cyclicality of interest rates and higher reinvestment risk "inherent in short-dated defensive assets" and should keep in mind the importance of balancing yields and risk to generate more consistent capital growth over time.

"Ironically, while income strategies were highly relevant amidst the extended low-rate environment, compressed yields and credit spreads have historically limited their capacity to produce decent returns," they said. 

"As the outlook for multi-asset income funds is improving on the back of higher bond yields and better diversification potential from higher-quality bonds and duration, these funds have a better chance to achieve a decent payout with less risk."

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