Income Investing When (Trade) Tensions Run High

Trade tensions—and the volatility they bring—are forcing investors to think about new ways to generate low-volatility income. We think a mortgage income strategy that balances high-quality securities with historically high-returning ones can help.

When it comes to income-oriented investing, we’ve long advocated a strategy that pairs return-seeking credit assets—high-yield corporate bonds, emerging-market debt and so on—with high-quality government bonds. This approach has historically reduced volatility and limited drawdowns, making it especially valuable late in the credit cycle.

But investors can do even more to reduce volatility sparked by geopolitical risk by adding mortgage strategies to their asset allocation. Why?

Because mortgage-backed securities are more resilient than high-yield credit to geopolitical risk. Consider the higher-yielding assets on the return-seeking side of the mortgage strategy, such as commercial mortgage-backed securities (CMBS) and credit risk–transfer (CRT) securities—a kind of bundled residential mortgage debt. As Display 1 shows, both have weathered the ups and downs of the US-China trade war better than high-yield credit.

Over the long run, complementary allocations to credit- and mortgage-focused income strategies may help smooth the returns of the overall mix, as the two have tended to outperform at different times.