Here's how to invest for yields to beat a bad year for stocks and bonds — according to the pros

Published Wed, Aug 3 20229:12 PM EDT

There's hardly any place for investors to hide this year, it seems. Stocks are volatile, and bonds haven't been doing better for much of this year. U.S. investment grade bonds have plummeted in 2022. The iShares Core U.S. Aggregate Bond ETF — which tracks the Bloomberg U.S. Aggregate Bond Index — has tumbled nearly 8% since the beginning of this year, although bond markets seem to have calmed a little recently. Historically, when stocks lost ground, bonds gained. That negative correlation turned positive during the pandemic, largely due to central banks cutting rates to stimulate the economy. But analysts have recently been bullish on income investing as yields start to creep up again, with Goldman Sachs saying in an August report that the strategy is set for a comeback. Here are some ways that the pros suggest investors can position their portfolios for diversification and protection against market volatility as well as seek higher yields as inflation continues to rise. The 60/40 portfolio The poor performance of stocks and bonds, coupled with high inflation has led some analysts to declare the death of the traditional 60/40 portfolio — made up of 60% stocks and 40% bonds. Inflation has typically been bad news for bonds. But some bank strategists have recently said that strategy would still work. Morgan Stanley said that that portfolio can still yield more than 6% annually — and the diversification continues to offer investors some protection from choppy stocks. Wells Fargo in an August 2 note said that this strategy is still "alive and well." Going by historical averages, the bank said, the negative performance is likely to be followed by double-digit positive returns over the next three years. "In the rebound phase following calendar years of negative 60/40 performance, stocks outperformed bonds by a significant margin, averaging 18.2% versus 4.5% respectively," Wells Fargo analysts wrote. "Finally, after the downturn in 2008, the 60/40 portfolio through year-end 2021 experienced positive returns in 12 of the last 13 years with double-digit returns in eight of them." The average yield of the Bloomberg U.S. Aggregate Bond Index has also jumped from about 1.5% to 3.5% since mid-2021 — the fastest one-year jump since 1994, Wells Fargo said. Consider high quality, investment-grade bonds In June, global credit suffered its sharpest pullback since the pandemic, and the first half of the year was the worst on record in terms of both excess return and total return, according to Wells Fargo Securities. But if investors are selective enough, they can still find pockets of relative safety in some bonds, according to analysts. High quality, long duration bonds would be the single best investment idea, Sarang Kulkarni, portfolio manager at Vanguard, told CNBC's "Squawk Box Europe" in late July. "From a valuation perspective, they've corrected quite a lot... It's not just treasuries, it's not just government bonds," he said, adding that high quality bonds have a "defensive characteristic" against inflation. The following are some bond funds that Morningstar, in a late July report, says have managed to beat their peers, as they're less sensitive to interest rates. Bond prices have an inverse relationship with interest rates. U.S.-domiciled Vanguard Short-Term Inflation-Protected Securities Index fund Invesco Corporate Bond (UK) M & G Corporate Bond Fund M & G Strategic Corporate Bond Consider thematic funds Investors could consider allocating between 10% and 20% of their portfolios to thematic funds, which play on secular growth themes and hence "have tremendous capability to enhance portfolio outcomes," according to Morningstar. The firm says such funds have recently grown in popularity, and focus on themes around tech innovation, consumer habits, among other areas. An equal-weighted thematic index "consistently generates better returns," with a compound annual growth rate of 7.48% compared with 6.28%, for the Morningstar Global Markets Index. "We believe thematic investing offers an attractive alternative to investors that do not wish to be restricted to regional and sector funds. We are of the view that if done properly, taking exposure to thematic investments can position investors for the blue chips of the future," said Morningstar in a recent report. Invest in infrastructure As the rise in consumer prices shows no sign of abating, infrastructure is a good investment because of its "ability to act as an inflation hedge in investment portfolios," said asset manager Franklin Templeton in a July report. "Infrastructure is typically able to adjust to inflationary environments due to the largely pre-programmed way it builds inflation into regulation and contracts," it said. The firm also pointed out that income from infrastructure is underpinned by long-term contracts, which ensure a steady flow of revenue over a long period of time.