Fixed Income  

Battle lines drawn in fight for income

Investors seeking stable medium to long term returns, such as those nearing retirement age, have traditionally favoured fixed income over equities.

However, as government bond yields are at historic lows, and stocks, which usually perform better, yield more, are investors looking in the wrong area?

At January 26 the bid yield on benchmark gilts maturing in 10 years was 2.09 per cent - less than half the 5.02 per cent bid yield on January 29 2007. That date was close to the the peak of the bull market before the credit crunch began in the summer of 2007.

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As equity income stocks have offered a better yield, and better prospects for capital growth, at a number of points in the last few years, the investment industry has reacted accordingly. The IMA has established a new Global Equity Income sector, in addition to UK Equity Income, in response to the growing number of funds targeting this asset class. It is even considering a European Equity Income sector if more funds are launched.

However, although equity income stocks are offering a much better yield, performance has not exactly been steady. For the year to January 26 the Global Equity Income and UK Equity Income sectors reported average losses of 0.06 per cent and 0.36 per cent respectively, according to Morningstar.

This compares unfavourably with the positive 5.63 per cent return from the IMA Sterling Corporate Bond fund and the surprising 16.77 per cent return from the UK Gilts sector.

In the longer term the equity income sectors did better, with a UK Equity Income three year return of 51.61 per cent compared with 36.74 per cent from the Sterling Corporate Bond sector. Over 10 years UK Equity Income again topped the four sectors with a return of 67.49 per cent, this time followed by a 59.89 per cent return from UK Gilts.

Meanwhile in spite of a poor performing 2011 the equity income sectors are already on the up this year. The UK Equity Income sector has returned 3.37 per cent for the year to date to January 26, according to FE Analytics, compared with a loss of 0.85 per cent from the UK Gilts sector. But what does this tell us about where investors should be looking for stable returns? Is equity income becoming the new fixed income, or do investors need to be able to blend the two strategies to gain the best results?

Ian Trevers, head of distribution at Invesco Perpetual, points out the volatility in global financial markets last year resulted in a marked trend towards risk aversion against a backdrop of prolonged low economic growth in the developed world.

“This combination has been particularly apparent in fixed interest. There have been strong returns for interest rate-sensitive investments and in particular for the perceived safe haven government bonds markets,” he adds.

“Meanwhile, some of the more credit-sensitive sectors have seen sharp price falls and widening spreads. This has left the search for income in the fixed interest asset class looking more than usually one-sided. Yields on core government bonds are at or near record lows, in many cases being negative in real terms. Investors need to be wary of a false sense of security in these investments - you are almost certainly locking in negative real returns over the next few years.