Income Investing Playbook 2025: Ideas for a New Rate Cycle

Introduction to Income Investing

Income investing is a strategy that aims to generate a steady stream of income from investments, typically through interest payments or dividends. Income investing is often favored by investors who prioritize regular cash flow. Income investments include a range of assets such as bonds, dividend-paying stocks, and real estate investment trusts (REITs). While income investing may offer less potential for significant capital gains, it can provide a reliable source of income and help diversify an investment portfolio.

Types of Income Investments

Below are three of the most common types of income investments:

• Bonds: Fixed income securities issued by corporations, governments, or municipalities that pay a predetermined rate of interest to investors.
• Dividend-paying stocks: Stocks of companies that pay out a portion of their earnings to shareholders in the form of dividends.
• Real estate investment trusts (REITs): Companies that own and manage income-generating properties such as office buildings, shopping centers, and apartment complexes.

Opportunities for Income Investing in 2025

After years of extraordinary monetary intervention, interest rates may be starting to normalize. Even with expectations that the U.S. Federal Reserve (Fed) will cut rates through 2025, long-term yields have remained high, particular as the rate cuts are expected to occur gradually and not aggressively. This shift toward a more normal yield curve may offer a welcome opportunity for income-focused investors, signaling a return to fundamentals and a potentially favorable backdrop for income.

Income Investing in 2025: Where to Focus

Investors are also facing a more uncertain economic environment in 2025, with slower growth in the U.S. along with evolving policies under a new incoming administration. Higher yields across fixed income markets may present compelling opportunities as they continue to provide a buffer against potential rate or credit spread movements. Venturing out on the credit spectrum may enhance returns as carry remains a key driver. For income investors, a strategic, longer-term view is more important than ever in navigating this dynamic landscape.

Determining the right mix of income investments for a broader strategic allocation will depend on each investor’s individual risk appetite. In the sections that follow, we provide the resources you need to better understand the risk and opportunities across the income investing landscape.

• Reduce Rate Sensitivity with Floating Rate Instruments
• Emerging Markets Bonds Remain Well Positioned
• Dividend Investing: Stocks Generate Income, Too!
• Tap into Midstream Energy for Yield
• Municipal Bonds Are a Staple of Any Income Allocation
• Investment Grade Bonds Are Attractive…If You Know Where to Look
• High Yield Benefits from “Fallen Angels”
• The Grass Gets Greener for Green Bonds

Reduce Rate Sensitivity with Floating Rate Instruments

While the risk of significantly higher rates has decreased with long-term yields at current levels, investments with less sensitivity to rate movements are still an important part of any broader fixed income allocation. Floating-rate instruments are an excellent way to gain exposure to the still attractive short-term yields, while still maintaining protection if rates take a turn higher. In addition, interest rate volatility has remained elevated, and because the prices of floating rate securities are not impacted by movements in interest rates, they can provide meaningful diversification within a broader fixed income portfolio.

In our view, these are three compelling ways to gain exposure to floating rate instruments:

1. Investment grade floating rate notes (FRNs)
2. Collateralized loan obligations (CLOs)
3. Business development companies (BDCs)

FRNs have coupons that are based on a short-term base rate, typically the Secured Overnight Funding Rate (SOFR), which reflect short-term funding costs, and an additional fixed spread that reflects the credit risk of the issuer. In the current “higher for longer” environment, investment grade corporate floating rate notes may continue to offer an attractive combination of enhanced yields and safety. The floating rate nature of FRNs means they have low or negative correlation to rate-sensitive fixed income asset classes, such as Treasuries or fixed coupon investment grade bonds. This may allow FRNs to fulfill two primary roles that fixed income can have within a balanced portfolio: income and diversification. Further, this is achieved without adding significant credit risk since the bonds carry investment grade ratings. This contrasts with leveraged loans, another floating rate asset class, which provide higher yields but with much higher credit risk. Accordingly, investment grade corporate FRNs may be an attractive complement to a cash-like portfolio.

We believe investment grade CLOs can help build better core bond portfolios. A CLO is a portfolio of predominantly senior secured bank loans (aka leveraged loans) that is securitized and actively managed. CLOs are not just a hedge against rising rates. They also have historically provided higher levels of income for a lower level of risk – making a clear case for a strategic allocation. Over the long term, CLOs tranches have historically performed well relative to other corporate debt categories, including leveraged loans, high yield bonds and investment grade bonds. The ability to capture attractive opportunities throughout the CLO rating spectrum can provide attractive income and total return opportunities in different market environments. Mezzanine CLOs can provide attractive overall yields even when the Fed is cutting rates, because of their substantial credit spreads, and can be an attractive complement to high yield bonds. CLOs are structured to help mitigate risk, through the strength of their underlying collateral, active management, as well as built-in protections such as subordination coverage tests to correct collateral deterioration. This has historically resulted in significantly lower levels of principal loss when compared with corporate debt and other securitized products.

BDCs are another alternative high income source investors should consider when looking to enhance yield in their portfolio by tapping into private credit, which can otherwise be hard to access. BDCs generate income by lending to, and investing in, middle market companies. BDCs provide capital to small businesses, and in turn, give investors access to the high income potential of middle market loans that are generally exclusive and difficult to access. While not without risk, BDCs have historically offered yields well above other high yielding asset classes.

Emerging Markets Bonds Remain Well Positioned

Emerging markets bonds offers a compelling investment case, particularly in the current global financial landscape. Emerging markets debt's appeal lies in three main areas: First, emerging markets demonstrate stronger fiscal responsibility with lower debt-to-GDP ratios and higher yields compared to developed markets, making them a beacon of fiscal prudence. Second, we believe that global trends in 2025 may benefit the asset class, such as ongoing geopolitical risk (which will keep commodity prices high), Chinese stimulus measures, and investor uneasiness with the lack of fiscal discipline in developed economies. Lastly, EMD's liquidity, lower default rates, and recovery values challenge the perception of higher risk, revealing it as a potentially safer and more rewarding option than its developed market counterparts.

Dividend Investing: Stocks Generate Income, Too!

Dividend-paying companies have maintained their appeal over the last 15 years, attracting investors in search of reliable yields amidst fluctuating interest rates. As we transition into 2025, the macroeconomic landscape is shifting. Despite receding inflationary pressures and an interest rate regime that has shifted from an upward to decreasing trend, uncertainty remains, which is why we believe it is prudent to focus on high dividend yielding U.S. companies with strong financial health and attractive valuations. This allows investors to gain exposure to high yielding companies, but hones in on those that have less of a likelihood of cutting their dividends and aren’t trading at excessive valuations.

Tap into Midstream Energy for Yield

The midstream energy segment, encompassing Master Limited Partnerships (MLPs) and corporations engaged in oil and gas storage and transportation, also presents a compelling opportunity for 2025. These entities are uniquely positioned to offer attractive dividend yields due to their critical role in the energy supply chain and their typically stable fee-based income. As investors seek resilient income streams amidst new U.S. administration policies and changing economic conditions, midstream companies may be particularly attractive. These firms are not only essential to energy logistics but also tend to offer higher distribution yields, making them a prudent choice for those looking to diversify their income-focused portfolios.

Municipal Bonds Are a Staple of Any Income Allocation

Municipal bonds present a compelling opportunity for income investors in 2025 due to their tax-exempt interest income, which could become increasingly valuable if individual tax rates rise following the potential expiration of the Tax Cuts and Jobs Act (TCJA). With the U.S. national debt exceeding $36 trillion and annual interest payments surpassing $1 trillion, fiscal pressures may lead to higher taxes or reduced government spending, further enhancing the appeal of these bonds. The Fed's ongoing rate-cutting cycle, expected to continue in 2025, historically increases demand for fixed income assets like municipal bonds. Additionally, Donald Trump’s proposed tax policies, including extending the TCJA, lowering corporate taxes and eliminating Social Security taxes, aim to reduce tax burdens but could also increase the national deficit, potentially leading to higher long-term interest rates. In this context, municipal bonds offer a stable and tax-advantaged option for income-focused investors navigating fiscal uncertainty and shifting tax policies.

Investment Grade Bonds Are Attractive…If You Know Where to Look

With investment grade corporate bond yields providing meaningful income while corporate bond spreads remain tight, we believe focusing on attractively valued bonds will become increasingly important in 2025. In particular, this approach has historically provided significant outperformance relative to the broader corporate bond market, driven by price gains as bond spreads compress and risk management as this strategy avoids bonds that don’t offer enough compensation for the risks involved. The market is not homogenous, and there is significant scope for mispricing to exist, particularly as market volatility continues and as we enter a more uncertain economic environment.

High Yield Benefits from “Fallen Angels”

Fallen angel high yield bonds, downgraded from investment grade to high yield status, offer a unique value in the bond market. They tend to be undervalued prior to downgrade and often recover afterward, leading to historical outperformance compared to the broad high yield market. Their distinctive attributes include systematic investment in oversold bonds, differentiated sector exposure, and higher credit quality. This has resulted in consistent outperformance across various market conditions, including different interest rate and spread environments. Although there has been a dearth of new fallen angels in recent years given the strong credit environment, we expect downgrades to increase in 2025. Fallen angels, typically issued by larger, established companies, also have a higher upgrade rate to investment grade, presenting a contrarian investment approach with a quality focus. With tight credit spreads as we head into 2025 and a potentially more uncertain economic environment ahead, we believe high yield investors should stay high in quality for now.

The Grass Gets Greener for Green Bonds

Green bonds are financing projects all over the world that have a positive environmental impact and provide a pathway to sustainable development. The green bond market’s explosive growth over the past decade has coincided with increased rigor and transparency. As the market matures, standards continue to tighten as recognition grows that increased ambition is needed along with greater green investment to meet global climate goals.

Green bonds have proven themselves to be an attractive solution for both issuers and fixed income investors. They have the same characteristics as a traditional bond, and thus a similar risk/return profile all else equal, but only finance projects and activities with a positive impact.