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.
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.
“On the other hand, yields in high yield corporate bonds or in areas of the market affected by the eurozone crisis, such as subordinated financial debt, yields are at their highest level for some time. There are opportunities across the corporate bond markets to lock in attractive income streams.”
However he adds that equity income funds are becoming more popular with investors seeking an income stream as well as capital growth from their investments.
“Equity income investing is about building portfolios which in aggregate exhibit above market dividend yield and, just as importantly, underlying dividend growth. The powerful combination of dividend yield and dividend growth has been known to investors for decades, with research to support the notion that this combination can produce above market average returns.”
Tony Stenning, head of UK retail at BlackRock, argues that investors are facing a challenging economic environment that is compounded by demographics.
“The global retirement population is rapidly increasing, with a 25 per cent chance of at least one member of every healthy 65 year old couple living to the age of 97. As life expectancy increases, investors will need to rethink about how to secure sufficient levels of income to fund retirement.
“While government bonds and cash remain in favour for investors largely because of the perceived safety they provide in terms of lower volatility, in the longer term investors should be thinking about ‘safety’ as the likelihood of achieving a positive real rate of return.
“Equities, in spite of possessing higher volatility, will play a critical role in helping investors achieve their retirement goals, particularly investment strategies such as equity income which offer a consistent income stream with the ability to keep pace with inflation.”
Eugene Philalithis, portfolio manager for the Fidelity MultiManager Income fund, agrees that investors have traditionally allocated their income generating assets to safe asset classes, such as cash and high quality government and corporate bonds for the dual properties of capital security and reliable income.
But he warns: “The yields on the highest quality government bonds and rates on cash deposits are at historic lows and investors are struggling to meet their income objectives.
“As an alternative investors could consider a multi-asset approach to income investing. Diversifying across multiple sources of income can help achieve the desired target of sustainable predictable income, with low capital volatility.”
Within equity income, he points out the UK has been a favoured destination, and one which according to the figures has performed well in most time periods, usually outperforming its global equity counterparts.
However, Mr Philalithis points out: “At a global level we are increasingly seeing companies establish robust dividend policies, which increases the breadth of opportunities for equity income investors and has raised the yield across major equity markets above their 15 year averages. We think dividends should be included in an income generating portfolio, but they are not the only story.
“We also see attractive and diversifying sources of income in investments such as property, real estate investment trusts (Reits), infrastructure and high yield bonds and loans, to name a few, as well as some parts of the investment grade bond market.
“The income from a single asset class can be subject to significant changes over time. However, diversifying across asset classes reduces the reliance on one source of income, so that if, for instance, equity dividends come under pressure, it only affects a portion of our income. By adding the flexibility to move the portfolio to high yielding asset classes away from low yielding areas, it is possible to maximise the income opportunity while controlling risk.”
Mr Trevers agrees that only focusing on either equity income or fixed income is not necessarily going to produce the best returns for investors.
“Equity income exposure can provide an added layer of diversification when used in conjunction with an allocation to fixed-interest investments in order to optimise a portfolio’s overall risk/return profile,” he adds.
“By investing in both equity income and fixed income, investors decrease their exposure to the risks associated with a single asset class investment while retaining the potential for strong long-term returns.”
Nyree Stewart is deputy features editor at Investment Adviser
