Still in the early innings of a recovery, European stocks are attractive from a valuation and growth perspective, plus the market's dividend payers are more diversified and generous than in the U.S., says J.P. Morgan's Anne Lester.
Jeff Holt: Hi, I 'm Jeff Holt, analyst with Morningstar manager research. Today, I'm joined by Anne Lester, global head of retirement solutions and portfolio manager for J.P. Morgan Asset Management. Today, we are here to discuss JPMorgan Income Builder (JNBCX), one of the strategies that she comanages.
Anne, based on its holdings, JPMorgan Income Builder falls in the conservative-allocation category. But as its name alludes to, it has a very distinct objective. Can you describe that objective, and how you strive to meet that objective?
Anne Lester: Well, our first objective is generating yield, and we have a very diversified overall pool of things to pick from. But we really try to keep the overall risk of the portfolio in line with a 60-40 stock/bond portfolio or lower. But beyond that, we go anywhere in an effort to try to maximize the yield we can find, always keeping that risk budget in mind.
Holt: Your portfolio can hold a lot of equities--as much as 50% in equities. Right now, it's around 40% in equities. One area you follow within equities has been European equities--you have a dedicated sleeve to that area. What's driving that interest in European equities?
Lester: We believe that Europe is several years behind the U.S. in terms of its economic recovery out of the financial crisis. The ECB is still aggressively doing QE; we've obviously stopped that and are now in the path--we think this year, probably--to raising interest rates. So, from a valuation perspective, we think that Europe is an attractive market. From a growth perspective, we think Europe is attractive. And very importantly, from a broad-market characteristic, European stocks have always historically paid higher dividends than the U.S. market does. And those dividends are more broadly diversified by sector than the U.S.
So, in U.S. stocks, if you want to yield portfolio, you're really stuck in couple of sectors. In Europe, you can get very diversified. Those are all reasons we like the market. And then, in particular, we really like the [portfolio manager] on the strategy that we are using; he's just done a terrific job and has a great eye for yield, but also growth. So, we are getting a great set of ideas from him in the portfolio.
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Holt: And jumping over to the fixed-income side, you have a lot of flexibility to move in different asset classes, and in fixed income, your portfolio has held as much as 50% in high-yield bonds.
Lester: 55%.
Holt: 55% in high-yield bonds. But that allocation has come down to an all-time low since the inception of the portfolio in 2007, around 20% in high yield--
Lester: Pretty close to 25% right now--
Holt: 25% in high-yield bonds. What drove the decrease in the bond allocation?
Lester: It isn't that we don't like high yield; it's that we like equities more. We had 55% in the end of '08 and beginning of '09, coming out of the financial crisis--getting both amazing yields and amazing total returns. Right now, we think we'll get similar yields, frankly, from a lot of our equities. We know there isn't going to be any real upside from a total-return perspective anymore.
So, we don't think the market is over; we don't think there is a big sell-off; we don't see a recession on horizon, which is one of the many things that causes high yield to sell off. We like the market, but we like equities more. That's really the bottom line. But in a fund that says "income" in the name--barring any real reason to hate the asset classes--it's likely that we'll always own some.
Holt: You don't just own equities and bonds; you also have some esoteric asset classes. You include REITs, and you include preferred stocks--and preferred stocks is one of those that you've gotten up to a 10% allocation in. What's the benefit of owning preferred stocks in an income portfolio?
Lester: For starters, they are great yielders. They are fixed-income-like securities. They pay a much higher dividend than a straight-up equity would. But they are also primarily issued by U.S. companies, and one of our thematic bets in the portfolio right now is an overweight to the U.S. We like that in all of our asset-allocation strategies that we run. But if you are an income portfolio, the U.S. equity market is kind of a lousy place to be because yields are so low and, as I said earlier, to get any yields you've got to go into sectors that we think are not terribly attractively valued. So, a lot of U.S. financial securities in the preferred space, we think, let us play the U.S. recovery, play where we are in the interest-rate cycle, and also give us significantly higher yield than just about anything else in the portfolio--6% or 7% yields there. So, it's attractive on just about every front from our perspective.
Holt: You have the flexibility to move across all these different asset classes--stocks, bonds, and some unique asset classes. What should investors expect from a risk-return standpoint for this type of strategy?
Lester: It's not going to feel as good going forward as it did looking backward. Maybe some people listening to this right now might say it doesn't feel very good right now. But we do think we've actually, if you look back over the last couple of years, had double-digit returns and single-digit volatility. And that's not normal, actually; that's abnormal. We think, going forward, we are going to be seeing single-digit returns and double-digit volatility. We're in an environment where, even if the Fed starts raising rates, we are not going back to normal for a long time. We think the new normal will be a bit lower. A 4% to 5% yield, we think, is achievable, but not much more than that. And you're going to have to own some risk to get there.
So, that trade-off is going to feel a little less comfortable than it has been. I think the market has probably gotten a little complacent about the level of volatility. Again, we are not by any stretch predicting a big sell-off like '08. But we do think normal market corrections are going to be something we see, especially when the Fed does raise rates. Nothing to knock our view that is constructive on risk assets, nothing to make us rethink that thesis, but we think we'll experience some more choppiness in the market.
Holt: Anne, thanks for joining us today.
Lester: Thank you very much.
Holt: I'm Jeff Holt for Morningstar. Thanks for watching.
