Consider Making Changes To Your Income Allocations

Includes: BOND, HYG, HYS, JNK
by: Michael Fabian

If you have found yourself recently falling in love with the positions within your portfolio, thinking to yourself "I wouldn't change a thing," it may be time to think twice. My convictions about the long term trend of the stock market and U.S. economic recovery still withstanding, I believe we are near a place where investors that have a large overweight position in domestic equities should circle the wagons and consider lightening up. My strategy for investing always starts with categorizing the difference between a core and tactical position, that way it's easy to identify the runners that you could cut loose near market extremes. As an example, an income investor that currently has 50-60% dividend equities could consider selling down to a 30-40% position while also ratcheting up their fixed income holdings. That way you are not sacrificing yield, but simply lowering your overall volatility.

For clients I particularly like actively managed, core fixed income options, such as the PIMCO Total Return ETF (NYSEARCA:BOND) or the DoubleLine Core Fixed Income Fund (MUTF:DBLFX) since they are not managed with interest rate hedges and carry a higher quality, higher duration portfolio. A market correction will typically cause interest rates to fall, resulting in capital appreciation with the added benefit of absorbing the pull back in your remaining equity holdings. Its strategic changes like this that will work to enhance your overall total return without completely removing yourself from additional stock market upside.

Evaluating the fixed income side of your portfolio may also unlock more ways to lower your overall volatility. Particularly, domestic high yield securities may not offer the benefits of spread compression that many investors have become accustomed to during this uptrend, such as the iShares High Yield Corp Bond ETF (NYSEARCA:HYG) or the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK). Investors of these funds are likely to receive only the benefit of income, rather than capital appreciation in the intermediate term. Which isn't enough to entice me to hold them, especially since high yield bonds can become extremely volatile during a market correction. However, those still interested in carrying some high yield exposure within their portfolio should consider moving down the curve to a fund like the PIMCO 0-5 YR High Yield Corporate Bond ETF (NYSEARCA:HYS). I favor this fund over its longer duration counterparts thanks in hand to both the expertise in security selection from an index construction standpoint, as well as the lower inherent sensitivity to interest rates.

Slowly weeding out areas that offer more risk than reward will better establish your portfolio's buoyancy if volatility rises. The key to making these changes is based on the philosophy that you would rather be two hours early instead of a minute late. I always make a habit of making changes when the market is calm and liquidity is abundant, as opposed to making changes in the midst of a crisis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Clients of Fabian Capital Management own HYS, BOND.