Bonds have long been the bedrock of income investing. For the more conservative investor, a multi-sector fixed income fund was the logical choice, offering stability and a reliable 4-6% payout by maintaining an investment-grade rating. When that wasn't enough, some sought higher yields, usually through high yield corporate bonds, with a globally diversified portfolio providing a meaningful pickup over conservative options.

But recent history has shown that simply chasing the highest yield can be a trap. We need only look at the cautionary tale of Asian high yield bonds before their 2022 reckoning. This market, once offering tantalising yields north of 8%, attracted billions in investor capital. But the high yield came with significant concentration risk. When the market turned, massive losses were recorded for many investors, leaving with a significant drop in fund assets.

The Income Enhanced Conservative Portfolio: For resilience and capital preservation

For conservative investors, the primary goal is a reliable income stream with a strong focus on capital preservation. 

However, the events of 2022 highlighted a critical vulnerability: When the two primary drivers of a traditional fixed income portfolio—interest rate and credit exposure—simultaneously declined, even well-managed portfolios suffered significant hits.

As central banks hiked rates and fears of slowing growth caused a credit market sell-off, even well-managed portfolios suffered double-digit drawdowns. This wasn’t a failure of portfolio management, but is considered a fundamental weakness of long-only funds, which are designed to be fully invested and, therefore, susceptible to broad market movements.

The solution is to build a more resilient portfolio by incorporating alphas—return drivers that are less dependent on the broader market, in a purposeful manner. This strategy involves strategically layering two distinct types of alpha on top of a traditional fixed-income foundation:

Defensive alpha for resilience:

This is achieved through absolute return fixed-income funds. These funds are not managed to a benchmark. Instead, they target an absolute return, for example cash plus a percentage, regardless of market conditions. 

By employing a wide range of strategies, including long and short positions, their returns are much less correlated to market factors. While they may not significantly boost long-term total returns, their role as a defensive diversifier is critical, providing a smoother path for the portfolio and freeing up a "risk budget" to enhance returns elsewhere.

Offensive alpha for higher returns

With a defensive component in place, the second enhancement focuses on manager selection and utilises the freed-up risk budget to generate higher returns. 

This involves selecting managers with a distinct edge, such as those with outstanding security selection capabilities or the ability to exploit market inefficiencies. For example, a fund that excels at deep, fundamental credit research; or one that uses credit default swaps (CDS) to gain exposure to high yield markets to benefit from the “liquidity buffer” during risk-off environments, offering downside protection can add significant value.

By blending these two sources of alpha, this Portfolio, primarily allocated to investment grade fixed income, with smaller exposures to absolute return strategies and high yield fixed income via CDS, is designed to target a strong risk-adjusted return. 

The Portfolio seeks to achieve an income level of 3.0% - 6.5% p.a. over a full market cycle and, in the current elevated rate environment, a target payout of 5.0% - 6.5% p.a. The result is a more controlled drawdown and a better return per unit of risk.

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The Income Enhanced Aggressive Portfolio: Potent and resilient high income

For investors with a higher risk tolerance, the objective is to maximise income generation and long-term total return. The traditional approach is a portfolio of high yield corporate bonds, which offers a higher yield but can be subject to tight spreads and concentration risk. 

As an alternative, a more sophisticated approach is to construct a portfolio that takes more measured and diversified risks across a broader universe of assets. This enhanced strategy is built on a two-pronged approach:

Top-down value-add

Strategic asset selection

Instead of tactically chasing the highest yield, this Portfolio strategically selects asset classes that can reliably add value over market cycles. This leads to three key asset classes:

• Frontier markets bonds: These bonds offer a sustained and attractive yield pickup over high yield bonds, averaging around 3.2% over the past decade through May 2025. While they come with higher downside risk, they can provide positive excess returns over the long term.
• Emerging markets bonds: The emerging markets debt universe is large and complex, and while its yield pickup may be less consistent than frontier markets, skilled managers can help navigate periods of prolonged underperformance and capture long-term risk premiums.
• Financial credit (AT1s): The primary purpose of these hybrid instruments, a modern form of bank capital, isn't to enhance yield but to provide diversification. They have a relatively moderate correlation to other high-yielding assets, making them a valuable component of an aggressive income portfolio.

Bottom-up value-add

Expert fund selection

Within each of these asset classes, manager selection is paramount. This is where skilled fund managers add significant value, particularly in complex areas like emerging markets and financial credit. By selecting funds with proven track records of outperforming passive options through expertise in security selection and dynamic management, the portfolio can further enhance its return potential.

By combining an expanded universe of assets with intentional portfolio construction, the Income Enhanced Aggressive Portfolio targets a more potent and resilient stream of high income. It seeks an income level of 4.5% - 9.0% p.a. over a full market cycle and, in the current environment, a target payout of 7.5% - 9.0% p.a.

This mix of frontier markets, emerging markets, and financial credit aims for strong long-term returns—while still controlling risk and maintaining an aggressive risk profile.

Risk and return comparison between Income Enhanced Aggressive and high yield asset classes

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The trade-off: Complexity and income variability

While these enhanced portfolios offer advantages, they aren’t without trade-offs. The primary drawback is increased complexity. These portfolios utilise more sophisticated strategies and instruments, such as derivatives and credit default swaps, making them more challenging for individual investors to navigate and evaluate. They also rely more heavily on the expertise of the portfolio managers than traditional benchmark-aware funds.

Furthermore, the focus on capturing returns from capital gains, particularly in the absolute return funds, can introduce more variability to the income stream. Unlike traditional funds that provide a consistent monthly payout from coupons, these funds may distribute on a quarterly basis, and their payouts can fluctuate.

However, this is a managed risk. By limiting the allocation to these funds, the overall portfolio can still provide a relatively consistent income stream while benefiting from the value-add of manager skills.

Ultimately, going from a “good” income portfolio to a “better” one requires a shift in mindset—from simply chasing yield to embracing smarter diversification, strategic asset selection, and the power of active management. 

For investors, this new approach offers a more resilient and rewarding path to achieving their financial goals.