portfolio pie chart

April 12, 2021

Revisiting Your Asset Allocation

Investors who have achieved healthy long-term returns with a traditional "60-40" investment allocation may need to explore alternatives and adjust their holdings in 2021 in order to meet future financial goals.

The long-favored traditional portfolio — 60 percent U.S. stocks and 40 percent investment-grade bonds — produced an average 10 percent annual return from 1975 through 2019, with stocks growing 12 percent and bonds 8 percent annually in that time, according to City National Bank's investment advisory affiliate, City National Rochdale. But that strong performance is unlikely to persist in coming years, given historically low interest rates and fully valued stock valuations.

In fact, City National Rochdale's investment team is forecasting that conventional 60-40 portfolios will average only 5 percent annual returns long-term, with investment-grade bonds adding only 2 percent and U.S. stocks averaging 7 percent growth in that time.

“We've lowered our longer-term expectations around some of our asset classes. You have to look for other sources of return," said Carolyn Finer, City National Rochdale managing director and senior investment strategist. "We are customizing our clients' portfolios to generate sustainable and consistent returns that are going to increase the likelihood of meeting their goals."

From adding less conservative assets to your investment mix, including high-yield bonds and alternative strategies, to shifting away from investment-grade debt in an effort to meet your return goals and satisfy future income needs, below are a few alternative ways investors might want to try generating returns in 2021.

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Setting Expectations

The impetus for the change comes primarily from City National Rochdale's forecast for continued low interest rates, which are indicated by the roughly 1 percent current yields on investment-grade corporate bonds.

"We don't see rates going down much further, but we do see them staying low for several years," said Finer. “And that's going to depress investment-grade bond returns for the next several years."

The government's recent financial relief package has sparked inflation concerns, but City National Rochdale sees that as a short-term phenomenon, according to Paul Single, managing director and senior portfolio manager.

"Inflation will move up over the next few months due to supply-demand imbalances. Shoppers have plenty of money and now have a place to go, they will spend a chunk of that money. We think shoppers will act just like they did following VJ day," he said.

"But after that, demand will return to a slower and sustainable pace. Supply imbalances will be corrected. Although the economy will be stronger, inflation will return to the 1.5 percent to 2.0 percent trend rate we have seen for the past 30 years," Single said. The relief package, he said, doesn't affect the firm's long-term forecast for low interest rates.

While investors historically sought reliable income and safety in high-quality investment-grade bonds, Finer noted, "that particular asset class is not working for them anymore."

Given rich U.S. stock valuations, portfolio managers also have shifted their equities strategy, although they continue to favor high-quality, reasonably priced U.S. stocks over those from other developed markets. While they anticipate more moderate returns on stocks than in the past, City National Rochdale investment leaders consider equities more attractive than high-priced, low-yield investment-grade bonds.

New Strategies

City National Rochdale's investment strategy committee develops broad strategic and tactical guidance across a range of risk profiles, with advisors customizing individual portfolios to address each client's specific needs, goals and risk tolerances.

As an example of a balanced risk profile, their optimized capital growth portfolio calls for:

  • 67 percent equities — 34 percent core, mostly high-quality large-cap U.S. stocks, 18 percent U.S. high-dividend, 6 percent mid- and small-cap U.S. shares and 9 percent emerging market Asia equities.
  • 20 percent opportunistic fixed income – generally high yield bonds, taxable or municipal, and other fixed income securities that provide higher yields than traditional investment grade bonds.
  • 8 percent alternative investments – examples include collateralized loan obligations, reinsurance, and other investments that can provide unique return, income, risk and diversification characteristics.
  • 5 percent real assets — mostly real estate.

The time frame isn't necessarily a retirement horizon, it's an investment horizon combined with personal comfort in risk and being invested for a certain time period, according to Finer. That would translate into at least a five- to seven- year intermediate horizon and 10-plus years for a long-term investment horizon, she said.

The investment managers expect this particular portfolio to average a 6.7 percent long-term annualized return, according to Finer, who noted that advisors customize the allocation for every client.

The High-Yield Debt Strategy

High-dividend stocks offer impressive yields around 4 or 5 percent, solid anticipated dividend growth and - given less heady valuations than the broader market - attractive potential price appreciation, according to City National Rochdale managers.

They're also pursuing opportunistic income strategies that focus on high-yield municipals and multi-sector taxable bond investments, carefully vetting and monitoring the inherent credit risk through rigorous research, Finer noted.

Portfolio managers consider high-yield corporate and municipal bonds to be attractive income replacements for investment-grade bonds.

"The higher-yielding and more credit-focused sectors of the bond market are where we see the opportunity moving forward," said Finer. “Those kinds of asset classes can perform well, and they can perform well even as rates increase."

Although managers are focusing on high-yield bonds with lower ratings, they aim for higher quality debt within that class, seeking to avoid "the junkiest of the junk," she said. "We're trying to create a portfolio with well-researched credit risk and lower interest rate risk that's going to meet the client's goals longer term."

Among the high-yield fixed-income opportunities they're targeting, the team may invest in non-rated municipal bond issues that are too small to pay for a credit rating, or revenue bonds backed by collateral such as property. "It is a higher quality strategy versus others in the high-yield peer group," Finer said.

Alternative Private Assets

In exploring alternative private investments, the City National Rochdale team seeks differentiated strategies with durable returns and a low correlation to traditional stock and bond markets, such as railcar leasing or healthcare royalty rights, Finer explained.

The railcar leasing strategy is a private investment with a $250,000 minimum required to participate. Capturing railcar lease payments, these investments offer a steady cash flow strategy, paying a nice dividend, providing tax advantages and higher expected returns, according to Finer.

"That's very attractive to our clients," she said.

While the team models 7 percent returns to be conservative, the railcar lease strategy's target is 8 to 10 percent annualized returns after fees, she said.

Investors participate in such capital leasing strategies as limited partners, with the investment in railcar leases underlying the limited partnership.

"You're buying into this consistent cash flow," said Finer. “Even in difficult times, the strategy has been very durable."

Companies lease railcars for four to 10 years and continue to make lease payments even in a slow economy. They want the assets ready to go when business picks up, she explained.

“The strategy is very well-diversified" in terms of railcar types, commodities and lessees, which mitigates economic cyclical risk, she said.

Credit Strategies

City National Rochdale portfolio managers also are focused on collateralized loan obligations - or CLOs - which are senior secured loans purchased from banks, packaged in a pool and issued as debt and equity.

These securities produce cash flow from interest payments, with targeted returns in the 8 to 10 percent range, according to Finer.

While returns generally are taxed as ordinary income and, therefore, may be less tax efficient than some investors want, CLOs are a great diversifier with a low correlation to the traditional bond market, she said.

"In fact, that was one of our top performers last year," generating returns higher than 15 percent, and one of the firm's most favored credit strategies moving forward, Finer noted.

CLOs carry additional volatility relative to other high yield segments of fixed income, but they have a steady track record of excess return while protecting investor capital, even during the worst recessionary periods, said Finer.

In these turbulent times, City National encourages you to review your investment portfolio with your advisor. Get in touch with a City National advisor today to ask questions and receive help with your wealth planning needs.

You also are encouraged to keep up-to-date with the latest economic perspectives and shifting global markets by signing up for City National Bank's newsletters here. Delivered biweekly, straight to your inbox.

This article is not to be construed as investment advice or as an offer, or solicitation of an offer, to buy or sell any financial instrument. Financial instruments discussed in this presentation may not be suitable for your individual circumstances. You should make your own investment decisions, using an independent advisor if prudent, based on your own investment objective and financial situation.

This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.

City National Rochdale, LLC, (CNR) a wholly-owned subsidiary of City National Bank, is a registered investment advisor providing investment advisory services to City National Bank clients.

This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

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