Equities 

The merits of multi-assets

It has been an incredibly challenging environment for income-seeking investors, who have seen interest rates on cash deposits remain stubbornly low and bond yields at or near record lows.

To compound matters, inflation looks set to remain around the Bank of England’s 2 per cent target rate, thus eroding an investor’s potential to generate a real return.

While fixed income and high-yielding stocks are popular sources of income, yield-seeking investors may wish to consider the merits of investing in a broader set of assets, particularly in the current economic and market environment.

The benefits of diversification within an investment portfolio have been well documented and they are just as powerful in the search for income as they are for capital growth. A multi-asset investment approach can successfully diversify and reduce the overall level of risk in an income portfolio, while also delivering a stable and sustainable level of income across the economic cycle. As income levels from different asset classes vary over time, a multi-asset approach allows investors to allocate away from those assets where the income is falling and towards those areas that are growing yield or offer capital preservation in market downturns.

It can also allow investors to gain access to the benefits of property, loans and infrastructure as alternative sources of income. Indeed, property-related assets and infrastructure show only modest correlations with equities and bonds, and contain an element of inflation-linking in their income. This can help reduce the risk of capital erosion as a result of increasing prices.

Substitute

An issue worth clarifying is whether property is a growth asset or a bond substitute. From an investment viewpoint, I classify assets based on the behaviour of their income and capital during the economic cycle. With this in mind, I consider property to be a growth asset because of its pro-cyclical capital behaviour and inflation-linked income. But it is important to recognise that the split of returns between income and capital varies depending on geography. Western European markets are much more bond-like in their behaviour, historically delivering around two-thirds of their returns from steady, relatively predictable income. So, in that respect, they are ideal for an investor looking for regular income.

In order to achieve a higher yield, all you need to do is look beyond the major cities to achieve high-quality income from high-quality buildings. In the UK, the property market tracked behaviour in the bond market up to 2009, at which point an unusual pricing dislocation opened up. Since then, unlike in bond markets, values outside the ‘AAA’ prime markets have actually been falling until recently – meaning yields have been rising. Non-prime yields had risen to such an extraordinary degree that, according to CBRE, the premium over 10-year gilts was a staggering 887bp in September 2013. There is a similar pattern in the core eurozone markets of Germany, France and Benelux, but the gap in the UK is the widest of any developed property market in Europe.