As we enter the final few weeks of the year, income has been a key watchword for most investors in 2014, with less focus on a multi-asset approach.
Income investors for the most part tend to be almost binary in their outlooks, adopting either an equity income solution or focusing on the fixed income yield from their portfolios. But is it really an either/or question?
John Stopford, portfolio manager and co-head of the multi-asset team at Investec Asset Management, argues: “The best way to manage income asset exposure is to take a broad, diversified approach. The world of income generation has widened and it is no longer just a bond story. There are other assets – such as high-yielding equities, property and infrastructure – that can provide part of an income solution.
“All income-generating assets these days bring risks with them because all of the safe assets are pretty expensive – cash rates are very low, government bond rates are very low – so if you want to generate more income you have to take more risks. Therefore, to manage that you need to strike a balance between opportunity and risk management.”
Talib Sheikh, manager of the JPM Multi-Asset Income fund, adds that concentration in one asset class can increase risks and lead to long-term underperformance, as opportunities in other sectors and markets are missed.
He explains: “For example, fixed income portfolios concentrated in core bonds expose investors to increased rate risk because their prices are most directly impacted by interest rates. Traditional income-generating investments may not provide enough yield and could actually incur losses if interest rates rise in a recovering economy. The key to generating higher income isn’t to avoid the safest investments or over-allocate to the riskiest; it’s combining many of them into a portfolio that pursues your desired returns while diversifying and managing risks.”
This doesn’t mean, however, that the benefits of equity income or bonds should be ignored, particularly when research from the latest Henderson Global Dividend Index suggests that total global dividends in 2014 are on course to reach a new high of approximately $1.2trn (£764.2bn).
Alex Crooke, head of global equity income at Henderson Global Investors, explains: “The US is particularly impressive, as American firms increase dividend payouts helped by rising profits. Globally, investors should reap approximately $133bn more in dividends this year than last.”
But with such a strong performance, is there the possibility of an income bubble in the equity space?
Stephen Thornber, global equity income manager at Threadneedle Investments, says: “After several years of good stock performance and bond yields at historically low levels, one could be forgiven for thinking that dividend stocks must have reached expensive levels. However, when you look at the valuations of high-dividend paying companies globally, they are still trading at a discount to the broader market.
“But not every dividend stock is a good investment. By focusing on companies with robust financial positions and good growth prospects we avoid false bargains or value traps, when an apparently high dividend may simply be a warning of trouble ahead, including the possibility of an impending cut in the dividend.”
While government bonds have come under pressure in the current macro environment, there are still opportunities within corporate credit, although the second half of the year has been more challenging for investors.
Peter Bentley, head of UK and global credit at Insight Investments, notes “in the second half, investors became increasingly concerned over the prospects of rising interest rates in the UK and US. However, demand for European corporate debt remained firm as the European Central Bank cut interest rates and took action to stimulate the economy.”
He adds that while October was volatile for all risk assets, including investment-grade corporate bonds, the results of the eurozone’s Asset Quality Review boosted markets as many banks received better-than-expected results, particularly those based in Spain.
Looking at bonds, which had a reasonable 2014, Jim Cielinski, head of fixed income at Threadneedle Investments, warns investors should be prepared for lower returns in the future.
“Over the past five years, fixed income has provided investors with significant positive returns. Government bond values have risen as market yields as a whole have fallen. Returns on corporate credits have been even higher as the difference in market yield between corporate bonds and government bonds has fallen to historically low levels. Looking ahead, however, prospective returns are likely to be limited by the extremely low level of yields now offered, particularly by government bonds,” says Mr Cielinski.
“Credit spreads have also declined significantly. Yields are approaching zero in many markets and investors clearly cannot rely on benchmarked ‘long-only’ fixed income strategies to deliver meaningful returns.”
So as we move into 2015, income investors would do well to consider all their options rather than simply putting all their eggs in one basket.
Nyree Stewart is features editor at Investment Adviser
Expert view
Kerry Craig, global market strategist at JPMorgan Asset Management, says:
“The combination of interest rate risk and already low yield suggests investors should diversify their fixed income investments and look beyond core bonds for income.
“Of growing interest is emerging market and high-yield debt. Many emerging market economies have better fiscal and trade balances than G7 countries, but offer higher yields, providing attractive opportunities to investors. Although they carry more risk, generous yields are available from emerging market debt, both in local currency and US dollar denominated.
“To obtain income from equities it is best to think of targeting sectors globally rather than individual countries as a global dividend strategy offers a wider universe of relevant stocks to invest in. There are many quality stocks with good earnings growth forecasts and with dividend yields that are higher than UK inflation.
“Think beyond traditional sources of income to beat inflation, and think multi-asset. This means taking on more risk, but a well-diversified portfolio can help reduce volatility. Think international, not single country or region.”
