Looking for high returns and low volatility?

While stocks get all the attention, bonds, preferreds, and other assets beckon.

Key Takeaways

  • High yields across a variety of asset classes could offer attractive opportunities for investors.
  • Focus on factors such as asset prices and credit quality and stay diversified.
  • Income investments that that can offer opportunities include medium-maturity US Treasury bonds, preferred stocks, short-maturity high-yield bonds, floating-rate bank loans, and energy pipeline master limited partnerships.
  • In exchange for higher income, some assets may experience more volatility than traditional income investments, but generally less than stocks.
  • Professional investment managers have the research resources and investment expertise necessary to help identify opportunities and manage the risks associated with higher-yielding security types.

With the S&P 500 hitting record highs, it's easy to lose sight of the much larger universe of investment opportunities that exists beyond those 500 US-listed stocks. But while it's true that stocks have been the best-performing asset class in 10 of the last 15 years, in 15 of the past 25 years, some of those other investments have outperformed stocks, even in years when stocks have returned close to their historical average of almost 10%.

That's something to keep in mind as the second quarter of 2024 begins. It's impossible to know how much longer stocks will continue to outperform other investments, so it may be a good time to learn more about those other relatively high-yielding opportunities. Indeed, because many investors' attentions are focused on stocks, some of these investments may be available at reasonable prices and they are also paying attractive interest rates—or coupons.

Adam Kramer manages Fidelity® Advisor Multi-Asset Income Fund (FAYZX) and he seeks opportunities in a wide variety of assets, caused by temporary mispricing of assets as investors overreact to fear or uncertainty. "In a good environment for stocks, there are still a lot of other opportunities out there," he says. "In fact, if you have the skill and research capabilities to find these opportunities, it's possible to get total returns that are close to the historical average returns of stocks, but with much less downside risk."

Kramer says that one reason why opportunities are appearing now is that uncertainty about where the economy is headed is causing genuine differences of opinion among investors about how to value assets in the marketplace. "The US economy is in the longest late phase of the business cycle since 1950, but market sentiment is more mid-cycle," says Kramer. "We're seeing some mid-cycle sentiment priced into some of the asset classes, while other asset classes are pricing in a recession. That's where the opportunity is, if you can find those mispricings, while avoiding things that are pricing in mid-cycle conditions, unless they offer really great coupon yields."

Finding opportunities in US Treasury bonds

Kramer says that US Treasury bonds with short- to medium-term maturities can be a good place to get attractive income with low risk and the potential for capital appreciation when interest rates move lower. Since the Federal Reserve began raising interest rates in 2022, rising yields have been accompanied by falling prices for Treasury bonds that were already in the market. Because bond yields and prices move in opposite directions, the increasing likelihood that yields and interest rates will move lower could provide an opportunity for Treasury prices to rise.

"These short and medium-maturity Treasurys are offering a very rare opportunity to 'do more with less,'" he says. "These bonds' relatively high coupon payments may offset the risk to prices that interest rates could stay higher for longer. That means they should also offer downside protection and could potentially generate significant single-digit total returns if rates move lower." For example, as of March 28, 2024, 7-year Treasurys are offering a 4.3% current yield. If the Federal Reserve cuts interest rates by 100 basis points in the coming months, you would earn your 4.3% coupon plus capital appreciation of 6%. That would mean your potential upside total return would be 10.3% when the Fed makes its first rate cut. If rates were to instead rise by 100 basis points, you would lose that 6% increase in principal, but the 4.3% coupon would limit the decline in the total return of your investment to only 1.7%, assuming you hold onto it for the entire 12 months. Says Kramer: "If you want the yield, liquidity, and low default risk of Treasurys plus the potential for rising prices when rates fall, this may be a good time to get those things at attractive prices."

Opportunities beyond Treasurys

While Treasurys may present a unique opportunity as the second quarter of 2024 begins, Kramer also says a wide variety of income assets may deliver stock-like returns with less potential volatility than stocks. That's especially a consideration if the economy does in fact slow down from its current late-cycle state. Stocks have historically outperformed both bonds and cash but during recessions, both bonds and cash have performed better than stocks.

Opportunities to do more with less are not secrets, but not all investment managers focus their attention on finding them. "Every manager's looking at stocks and investment-grade bonds," says Kramer. "Not as many are doing the work on other securities, but if we do the research, we can find opportunities."

One opportunity may exist in fixed-to-floating preferred stocks. Despite their name, preferred stocks are actually hybrid securities that in some ways resemble bonds but also represent equity shares in the companies that issue them.

Kramer likes preferred stocks of investment-grade US utility companies, master limited partnerships (MLPs), and big US banks, particularly those whose interest rates are either rising now or are scheduled to do so in 2024. "I think that those may be great ways to earn high, single-digit yields now while you wait for their prices to rise. Right now, you can buy them for less than their face value and their issuers can choose to buy them back from you for face value. If they don't choose to do that, the interest rates that they pay may increase and you could earn a higher return that way. If you're looking for income, you'd probably rather collect an 8% or 9% current yield on these fixed-to-floating preferreds than a 3% dividend yield from the stocks of these same companies."

Opportunities in short-maturity, high-yield corporate bonds

Another group of income-producing assets likely to offer attractive returns in 2024 are bonds issued by companies whose credit ratings are just below investment grade.

Kramer says that the short-maturity, high-yield bonds issued by these companies can provide an attractive alternative to owning those companies' stocks, especially in a recession. In past recessions, bond prices have historically risen while stock prices have fallen. Right now, the coupons on many high-yield bonds are also higher than they have been in recent years. Those coupon payments, as well as their prices in the marketplace, contribute to the total return of these bonds.

Kramer says the default risk of companies rated just below investment grade has historically been low and he explains, "I feel like you're getting a bigger bang for your buck in high-yield bonds than in stocks of the same companies. If earnings decline, high-yield bond prices are likely to be less volatile than stock prices. High yield is also attractive because more than 50% of the market is currently rated just below investment grade and presents relatively little credit risk. That's unusual. So even if the economy gets worse, you could still earn close to 10% on high yield with typically much less volatility than stocks." In a diversified portfolio, those high yields could potentially offset declines in asset prices that often accompany economic slowdowns.

Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions. Credit quality also varies widely among high-yield bonds, so careful research is important.

Opportunities in loans and MLPs

Kramer has also found opportunities in floating-rate loans that banks make to companies and then sell to investors. Credit quality is an important consideration for investors in loans and Kramer is focusing on loans to what he believes are high-quality companies. "If you're getting a 9% current yield on a loan to a company such as Uber or Four Seasons Hotels or Bass Pro Shops, it matters less what's going to happen with the short-term market prices of these securities," says Kramer.

Securities issued by master limited partnerships (MLPs) that own and operate oil and natural gas pipelines are another place where one can currently find 8% to 9% yields. "In the past, master limited partnerships were shunned because everybody was down on energy pipelines and production, but we do need oil and gas," says Kramer. "These companies have been reducing their capital spending and acquisitions and their free cash flow yield is expanding as a result. This is a situation where the payout ratios have been dropping into the 50s, which is quite attractive for something that can have around a 9% dividend yield."

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  • Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.
  • Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.
  • Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.
  • Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.
  • Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.
  • Past performance is no guarantee of future results.
  • Diversification and asset allocation do not ensure a profit or guarantee against loss.
  • In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
  • Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for investments that focus on a single country or region.
  • High-yield/non-investment-grade bonds involve greater price volatility and risk of default than investment-grade bonds.
  • Floating-rate loans generally are subject to restrictions on resale. They sometimes trade infrequently in the secondary market, so may be more difficult to value, buy, or sell. A floating-rate loan might not be fully collateralized, which may cause it to decline significantly in value.
  • Preferred securities are subject to interest rate risk. (As interest rates rise, preferred securities prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Preferred securities also have credit and default risks for both issuers and counterparties, liquidity risk, and, if callable, call risk. Dividend or interest payments on preferred securities may be variable, be suspended or deferred by the issuer at any time, and missed or deferred payments may not be paid at a future date. If payments are suspended or deferred by the issuer, the deferred income may still be taxable. See your tax advisor for more details. Most preferred securities have call features that allow the issuer to redeem the securities at its discretion on specified dates, as well as upon the occurrence of certain events. Other early redemption provisions may exist, which could affect yield. Certain preferred securities are convertible into common stock of the issuer; therefore, their market prices can be sensitive to changes in the value of the issuer's common stock. Some preferred securities are perpetual, meaning they have no stated maturity date. In the case of preferred securities with a stated maturity date, the issuer may, under certain circumstances, extend this date at its discretion. Extension of maturity date will delay final repayment on the securities. Before investing, please read the prospectus, which may be located on the SEC's EDGAR system, to understand the terms, conditions, and specific features of the security.
  • Investments in publicly traded MLPs involve risks and considerations that may differ from investments in common stock. Tax complexity risk: Master Limited Partnerships (MLPs) are generally considered pass-through entities for tax purposes and have special tax considerations. Pass-through entities may generate unrelated business taxable income (UBTI) that may have undesirable tax consequences for retirement accounts and other tax-exempt investors. If you hold MLP units, you are generally treated as a partner for tax purposes and will be issued a Schedule K-1 (Form 1065) rather than a Form 1099 form for use in filling out your tax return. A K-1 lists the partner's share of income, deductions, credits, and other tax items. If the MLP has operations in multiple states, you may need to file a separate tax return in each state. An MLP that is treated as a corporation in the United States rather than a pass-through entity for federal income tax purposes would be obligated to pay federal income tax on its income at the corporate tax rate. In this case, the amount of cash available for distribution by the MLP would be reduced and part or all of the distributions made could be taxed entirely as dividend income. In this case a Form 1099 would be furnished rather than a Schedule K-1. Please see the MLP's website, SEC filings, or most recent shareholder report for further details about tax treatment of your investments. Legislative risk: The tax treatment of publicly traded MLPs could be subject to potential legislative, judicial, or administrative changes, possibly on a retroactive basis. Any such changes in tax treatment could negatively impact the value of an investment in an MLP. Concentration risk: Many MLPs are concentrated in the energy infrastructure sector. This narrow focus of MLPs may present considerably more risk than a diversified investment across numerous sectors of the economy. Market risk: MLPs may exhibit high volatility particularly during periods of economic stress or due to other events impacting the particular sector or industry in which an MLP operates. Interest rate risk: The market prices of MLPs are sensitive to changes in interest rates. As interest rates rise, the prices of MLP units may decline (and vice versa). Rising interest rates could also increase the MLP's cost of capital which may limit potential growth through acquisition or expansion and reduce distribution growth rates. Distribution policy risk: All or a portion of an MLP's distribution may consist of a return of capital from your original investment. MLP unit holders should not assume that the source of a distribution is net profit from the MLP's operations. Liquidity risk: Despite the fact that MLPs are publicly traded, investments in MLPs may be relatively illiquid due to their unique investment strategy, asset concentration or other factors. Lack of liquidity can negatively impact your ability to sell MLP units. Additionally, should a secondary market exist, investors who need to sell MLP units may be subject to a significant loss. Commodity price risk: The price of MLP units may be negatively impacted by fluctuations in commodity prices. A significant decrease in the production or supply or sustained reduced demand for natural gas, oil, or other energy commodities would limit revenue and cash flows of MLPs and, therefore, the ability of MLPs to make distributions to unit holders. Regulatory risk: The assets of MLPs tend to be heavily regulated by federal and state governments. Changes in regulation can adversely impact an MLP's profitability and therefore the value of MLP units. Conflicts of Interest: The general partners of an MLP typically have limited fiduciary duties to the MLP and may have conflicts of interest which could result in the general partners favoring its own interests over the MLP's interests.
  • Value stocks can perform differently from other types of stocks, and can continue to be undervalued by the market for long periods of time.
  • The gold industry can be significantly affected by international monetary and political developments such as currency devaluations or revaluations, central bank movements, economic and social conditions within a country, trade imbalances, or trade or currency restrictions between countries.
  • Fluctuations in the price of gold often dramatically affect the profitability of companies in the gold sector.
  • Changes in the political or economic climate, especially in gold producing countries such as South Africa and the former Soviet Union, may have a direct impact on the price of gold worldwide.
  • The gold industry is extremely volatile, and investing directly in physical gold may not be appropriate for most investors.
  • Bullion and coin investments in FBS accounts are not covered by either the SIPC or insurance "in excess of SIPC" coverage of FBS or NFS.
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