As Franklin Templeton releases its global midyear investment outlook, investment managers at the firm discuss where income-seeking investors can find opportunities in the second half of 2022.

Faced with a challenging start to 2022, ranging from high inflation, rising interest rates and a risk of recession, investment managers at Franklin Templeton says clients must look beyond equities and conventional bonds to earn returns in coming months.

According to the US-based global investment manager, the first half of 2022 created another challenge as equities and fixed income both showed similar downside volatility in lockstep with each other.

“Income-focused investors must be active and nimble against this shifting backdrop, casting a wider net as rising interest rates have led to a reduction in the principal value of fixed income and equities,” Stephen Dover, chief market strategist at Franklin Templeton Investment Institute, stressed.

Templeton believes that the addition of alternative assets such as real estate and infrastructure to a portfolio can offer both a less correlated source of yield, while diversifying for better protection of principal.

If investors held any excess cash, this provided protection from the volatility of other assets and now provides liquidity to invest in income-producing assets at more attractive values and higher yields, Templeton explained.

It is a balance of accepting reasonable levels of risk to enhance the yield of their portfolios, while diversifying income sources to protect principal.

Franklin Templeton investment managers outline their differing views below on the best way to approach income investing in this environment.

Risks present opportunities
According to Ed Perks, chief investment officer at Franklin Templeton Investment Solutions: “This volatile environment has also uncovered opportunities. One of these opportunities is in higher-quality fixed income securities, particularly those with longer duration or more exposure to interest rate increases. We’ve seen historic selloffs in bond prices, and the yields that investors can buy into now are significantly higher than they were just six to nine months ago.”

For Brian Giuliano, client portfolio manager at Brandywine Global, opportunities exist in the corporate credit space with companies that have pricing power given the inflationary backdrop.

“We think staying higher in credit quality is sensible given where we are in the cycle and economic headwinds,” he said.

“If market conditions continue to deteriorate, increasing exposure to high-quality government bonds would be wise and could offer return potential through appreciation if yields fall in reaction to a slowing economy, as well as a source of uncorrelated return relative to credit assets and equities,” he added.

Meanwhile, Reema Agarwal, portfolio manager at Franklin Templeton Fixed Income, believes that bank loans – also known as leveraged, floating-rate or senior secured loans – tend to act as a good hedge against interest-rate risk.

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Equity focus
Accepting some equity risk in the form of dividend-paying stocks may be attractive to enhance portfolio yield and protect against rising inflation, the firm added. According to Michael Clarfeld, portfolio manager, ClearBridge Dividend Strategy: “Dividend growth is great in regular periods, but critical during inflationary periods. As inflation erodes the value of a dollar, growing dividends help to maintain purchasing power despite the increasing cost of living.”

“In some ways, managing income is part of managing volatility. Companies that have more predictable cash flows and more resilient dividends are likely to be less volatile. The key is to invest in high-quality, blue chip companies, which allow for better dividend growth and stronger dividend resilience during difficult times,” Matt Quinlan, portfolio manager, Franklin Equity Group, added. 

Alternative focus
“Infrastructure assets act as an inflation hedge due to the largely pre-programmed way – through regulation and contracts – infrastructure adjusts to inflationary environments,” Shane Hurst, portfolio manager, ClearBridge Investments, said.

Historical precedence suggests that private real estate can effectively hedge inflation as a steady income-producing asset. The industrial and multifamily segments merit particular attention now.