Thu, 20 Jun 2013
JP Morgan's Ann Lester says the relative advantage of high-yield assets is waning and that non-U.S. dividend-paying stocks can offer broader diversification and better total return.
Josh Charlson: Hi. I'm Josh Charlson with Morningstar. I am here at the Morningstar Investment Conference to talk about initiatives of great concern to investors, and that is: How do you generate yield in a market where yields are very low? To help us with that question, we have Ann Lester from JP Morgan. Ann is a managing director at JP Morgan and oversees a number of the portfolios there, including JPMorgan Income Builder and the SmartRetirement target-date funds.
Thanks for being with us, Ann.
Ann Lester: Thank you, Josh.
Charlson: So, as I framed the question, real and nominal yields are both very low from historical levels. So investors, if they want to find yield, it seems like they have to go out on the yield curve or go into riskier sectors or asset classes. Is it worth it for investors to be out there looking for yield in that way? What is your view on the question?
Lester: Well, it's hard to answer sort of generically "Is it worth it?" I think every investor or every advisor has to really try to understand what that particular client's goals and objectives are. Certainly, I don't think you can try to keep yields stable from where they are right now, or increase them without also increasing risk, and I think that didn't used to be true. Last year or the year before you could really get higher yields, you could really expand into new asset classes for some investors, without having to stretch on the risk side, and I don't think that's true anymore.
Charlson: Talk a little bit about your asset-allocation process in the Income Builder fund, where yield is more of a focus for you. You've a pretty wide landscape of asset classes you can use. How do you determine what you're going to look at and what are sort of the risk factors that you're looking at, as well?
Lester: So just about any asset class that generates yield we want to consider for the fund. And the team really tries to generate an 18- to 36-month forecast with insights from the bottom-up managers in the individual asset classes to help us understand where we see relative attractiveness from a yield perspective and to understand what we're going to be paying for that in terms of volatility and where those correlations are going. Really as a result of the entire globe rushing into the search for yield, we've seen those yields compress everywhere. The more obvious places that we were going for yield, like high yield, for instance, we think are maybe not played out, but certainly less interesting relatively speaking. Some other parts of the financial world, like the equity market, we think still represent some interesting opportunities, not just because of the yield, but also because of the total return.
Charlson: Now, let's talk about a couple of those areas. High yield is an area where JPMorgan in particular and your funds, you've had a significant overweighting there since probably late 2008.
Charlson: You scaled back a little. What are the factors there? What are your views on high yield right now?
Lester: Sure. We've actually scaled back, I'd say, a lot. So, we've gone from an all-time high at the end of 2008 of over 55%, 56%, 57%, and we're under 30% now. So it's something like 28% now in high yield. So, that's been a dramatic, almost cut-in-half, change, and we've taken that money and put it into things like preferred equities, into outright equities, and increased our allocation to nonagency mortgages over time. For us, it's not that high yield is necessarily overvalued in the sense that spreads are tight. Spreads are actually kind of near their long-term historical averages, and defaults are still very, very low.
So, if you just look at those two signals, things seem fine. The bottom-up health of most of the companies, all the companies that we're invested in for sure, is still very robust. Nobody needs to refinance anything very quickly. So from that perspective, those are all very healthy signs we think of for a well-functioning market and frankly of relatively low risk of default, which is the typical trigger for big widening in spread.
The flip side, though, is that absolute yields are absolutely rock-bottom. And if we just look at the literal yield we can get from a high-yield pool and compare it with an income-focused equity pool, the differential is not very big anymore. So again, when we look at that relative attractiveness, we just don't see it.
Charlson: Now, in terms of equities, that's another area where investors have put a lot of money, dividend-oriented equities in particular. Have valuations gotten too high, or are they still favorable at least relative to other asset classes? And particularly, I know you've looked abroad for some dividend-paying companies. What are some of the opportunities there?
Lester: Well, I think I'd say, broadly speaking, the equity managers that we're working with who pick the individual securities for us, so we asset allocate on my team where we have individual portfolio managers who are picking individual stocks and bonds. So the equity managers, broadly speaking, are really looking not just for the highest-yielding stocks. In fact, they often steer clear of those. And what they're really looking for are companies who are growing businesses, have a healthy cash flow stream, and are choosing to take some of that cash flow and reinvest some of it in the business, but also pay some of it out in dividends. So, some of those most expensive income stocks actually are not ones that we have owned because they don't fit that profile of growing the dividend, growing the business, growing the cash flow.
Secondly, going overseas helps us find a broader diversified basket of securities. So, if you look at U.S. income funds, they typically are very concentrated in three or four sectors. When we look at our equity portfolio on a global basis, we're actually very much more diversified across multiple sectors. And again, we think that allows us to keep the yield interesting, and again non-U.S. companies historically have paid significantly higher dividends than U.S. companies. But also just own a better basket of securities. So that helps us ride through some of the volatility we're seeing now.
Charlson: How much of an advantage in terms of dividend yield do you typically get by investing in an overseas company?
Lester: So, if you look at the dividend yields of the global index ex-the U.S., it's over 100 basis points higher. So, if you think about the U.S. at sort of 2%-ish and [ex-U.S.] is sort of over 3%, without even doing any security selection, you've already almost increased by 50% the yield that you're getting. When you do some pretty careful stock-picking and asset allocating inside of that basket, you can get it up to something over 4%, so that's a tremendous pickup.
Charlson: The last question I have might be a little bit difficult to answer because I'm asking you to answer generically. But for an investor looking to develop a diversified portfolio that can generate yield, what do you think a reasonable yield target is in this environment?
Lester: Well, I can tell you what our fund is currently playing, which is in the [4% range]. We like to look at rolling 12-month distribution yields because that gives us a sense of sort of how things are going. I think it's really hard to get something north of 5%, unless you take a lot of very concentrated risks either in sectors or in specific securities. I think as long as the Fed doesn't raise interest rates and, again it's obviously market-dependent, assuming equity prices stay where they are or creep a little higher, yields will keep coming down. So, I think something in the 4s is attainable.
Charlson: Thanks so much for joining us today.
Lester: Thank you very much, Josh.