Schroder investment: In a volatile financial market, it is necessary to diversify sources of income. Credit and high dividend rates can effectively supplement.

Schroders global investment report stated that this summer, the Bank of Japan will raise its benchmark interest rate to 0.25% by the end of July 2024, causing financial markets to become tense and anxious, particularly triggering a domino effect in the stock and fixed income markets. Subsequently, the Standard & Poor's 500 VIX panic index soared to its third highest historical record. Therefore, it is necessary to diversify from traditional sources of income, such as credit and high dividend stocks, in order to effectively supplement existing income flows throughout the economic cycle. Investment-grade corporate bonds and high-yield bonds have traditionally been seen as the foundation of income investment portfolios. Convertible bonds, securitized credits, and insurance-linked securities are other alternative income sources that investors should consider. From a diversified asset investment perspective, these asset classes are promising because they have lower correlations with stocks and fixed income, while also having the potential to provide attractive income levels and improve risk-adjusted returns. In an environment of high inflation and high interest rates, the correlation between bonds and stocks remains high. When investors consider how to generate income, they should reevaluate the role of traditional bonds as diversification tools in their portfolios. Fixed income investments can indeed generate income, but interest rate risks are twofold. Traditional income sources Schroders global believes that investment-grade corporate bonds and high-yield bonds have traditionally been seen as the foundation of income investment portfolios. In the high-yield bond category, a large amount of debt has been issued in recent years, with some of it maturing in 2025, requiring refinancing. In a prolonged environment of high interest rates, the cost of refinancing will be higher. Therefore, investors should pay special attention to potential refinancing risks. At the same time, the credit spreads of investment-grade corporate bonds are small, and valuations remain expensive (currently around 20%). In this context, it is important to continue seeking diversification and alternative sources of income. How do other income sources complement the investment portfolio? Convertible bonds, securitized credits, and insurance-linked securities are other alternative income sources worth considering for investors. From a diversified asset investment perspective, these asset classes are promising because they have lower correlations with stocks and fixed income, while also having the potential to provide attractive income levels and improve risk-adjusted returns. Convertible bonds: Given that interest rates are declining, convertible bonds can capture attractive upside potential. Compared to direct investment in stocks, convertible bonds offer a flexible option with lower downside risks. The issuers of convertible bonds are typically medium-sized businesses that can benefit from a rate-cut environment. Securitized credits: This asset class dominates the US bond market and can provide diversified income, making it an alternative choice to traditional corporate bonds. Securitized credits offer different driving factors from traditional credit, being related to cash flows from consumers, housing, and other real assets. Compared to US investment-grade bonds, they can increase yield and credit quality while reducing duration. Insurance-linked securities: These assets aim to transfer insurance risks from insurance companies to capital market participants, with limited or almost no correlation to traditional stocks and fixed income. Their returns are based on factors such as the frequency and severity of natural disasters, which can result in insurance losses, such as earthquakes and hurricanes in high-insured peak areas. Insurance-linked securities (ILS) can provide risk-adjusted returns and have lower correlations with macroeconomic trends and traditional assets. A common type of insurance-linked security is catastrophe bonds (cat bonds). Impact of climate change on insurance-linked securities Climate change is increasingly leading to a growing demand for insurance protection, bringing both threats and investment opportunities. However, climate change is a gradual long-term phenomenon, while typical insurance-linked securities are short-term investment products. Furthermore, in the process of considering climate change, only weather-related insurance risks are affected. Other natural disaster risks such as earthquakes (key drivers of tail risk in the entire insurance-linked securities market) are not affected. As long as potential risk models can appropriately reflect the increased risk levels associated with these trends, and risks are properly hedged, broader trends will continue to provide attractive investment opportunities for insurance-linked securities investors.