For this post, we had the privilege of interviewing John Thompson, a partner and head of the Investment Advisory Solutions Group for Aon Hewitt Investment Consulting Inc.’s financial intermediary clients. He shared his insights on constructing growth and income portfolios, including the use of dividend paying equities and MLPs in income portfolios and smart beta and emerging markets strategies for growth.
1. What’s the rationale behind including income producing equities in the income portfolio?
Income producing Equities and different types of Fixed Income combined tend to work well together in a diversified income portfolio. High income stocks have historically demonstrated less volatility than the stock market as a whole, so we believe adding these types of securities can make sense when you are looking to draw income from your assets while balancing asset preservation alongside some potential long-term growth. The income producing equities offer potential valuation growth while producing current income.
2. MLPs have become a hot topic with income investors, first because of their high yields and distribution growth, and now because of their heightened volatility amid an oil glut. What’s your take on including MLPs within an income portfolio?
MLPs may deserve a place in an income portfolio because of their current high yield and potential diversification benefit. The news and sentiment surrounding an oil glut has already affected MLP prices. Should oil prices go up from here and MLP prices were taken down because of sentiment linked to the oil glut, then there is room for a potential price increase in MLPs to accompany the relatively high income they are producing.
3. Should growth investors be worried about a decade of low equity returns as suggested by some valuation models and slowing profit growth? If so, what are some tools investors can use to make up for a growth shortfall? Are smart beta strategies a viable method of helping enhance returns?
Investors are rightly concerned about growth given the recent bull market and global economic sentiment. Despite suggestions of lower returns, we currently construct our growth model portfolios with an eye to finding opportunities across the globe. Some equity markets such as Emerging Markets actually may outperform over the next market cycle given their current valuations.
Historically, Smart Beta or risk premium investing is a viable means of potentially enhancing returns because it provides a way of constructing the portfolio to have exposures to certain risks or investment factors that may enhance returns and reduce volatility and sometimes both. Most recently factors such as Emerging Markets and value have been out of favor. Both the growth and income portfolio are constructed to take advantage of a market shift back to value and more global securities.
4. Aon’s growth portfolio assigns a weighting of 15% to Emerging Markets, which is an overweight relative to Emerging Market’s position in global market cap weighted benchmarks. What is your outlook for emerging markets in the context of low commodity prices and rising rates in the US?
According to our March 2016 Medium-Term Views, which encompass a one-to-three year outlook, we find Emerging Market stocks to be “cheap” from a valuation standpoint. In our view, the big negative news from the commodities rout and currency depreciation is already priced into emerging markets. Now, the potential for a spring-back is building. We see potential for growth over the next few years relative to other equity markets
5. Aon takes a medium-term outlook for portfolio construction, rather than the more commonly cited long and short term outlooks. What are the advantages to basing portfolio decisions on a medium-term outlook?
When we build portfolios, Aon takes the long-term into account, but we also recognize that shorter market cycles may present investment opportunities. We believe in long-term asset allocation, but we give a nod to disruptions in market cycles and may adjust portfolios given opportunities to make potential improvements.