With interest rates at historic lows globally it’s no wonder investors are looking around for the best sources of income.
The bond sector has long been regarded as the ‘safe’ option for income investors. However, while investors continue to move into these perceived safer assets sovereign bond yields are also hitting record lows, with 10-year UK gilt yields at roughly 1.72 per cent and US 10-year government bonds at 1.57 per cent, there are concerns the asset class is too expensive and is being called by some as the next big investment bubble.
Mouhammed Choukeir, chief investment officer at Kleinwort Benson, notes: “Persistent budget deficits and weak economic growth will continue to lead the UK Treasury to ‘load up’ on government debt. It is difficult to justify lending the government money for the next 10 years only to be paid 1.8 per cent. In fact, after adjusting for inflation, investors would have to pay the government for the privilege as 10-year real yields are at -0.7 per cent.”
However, he adds that while government bonds are overvalued, “they continue to experience positive momentum, sentiment is oversold and the economic climate is favourable. Importantly, government bonds act as effective diversifiers in times of crisis by preserving value when equity markets sell off significantly”, he explains.
For those investors who prefer fixed income, corporate bonds remain an attractive asset class for some investors, with Neuberger Berman’s global fixed income team noting that increased monetary stimulus by central banks supports a steepening yield curve position in most developed bond markets.
But for many investors income is most likely to come in the form of equity income and most importantly dividends, particularly as research from Capita notes 2012 will be a record year for UK dividends, at an estimated £78.6bn, a 15.6 per cent increase on 2011.
Income is a key objective for most investors, but how they go about sourcing it depends entirely on the risk profile and overall investment objective of a client. The key is to make sure they understand the risks they face. Equity income may pay higher dividends, but at a risk of volatility and the discretion of market sentiment, while bond investors may feel safer in the asset class, but at least in terms of government bond spreads they will have to pay for the privilege.
