As we enter 2017, the UK’s rising inflation – consumer price index growth is currently at 1.6 per cent – combined with a weaker currency ahead of Brexit negotiations, means the search for income remains a significant focus for many investors.
Helped by capital growth, last year the IA Global Emerging Market Bond sector produced a higher average return in sterling terms, at 24.8 per cent, than the IA Global Equity Income sector average of 23.2 per cent, while the IA UK Equity Income sector lagged behind even when currency movements are discounted, data from FE Analytics shows.
This suggests investors need to look more carefully at income strategies in 2017, especially with political upheaval and economic uncertainty set to continue.
David Lafferty, chief economist at Natixis Global Asset Management, says: “Last year proved a rollercoaster for income investors. The perception of safety and the need to generate yield in a negative-rate environment drove investors to high-quality bonds and dividend-paying equities early in the year. But fears eventually gave way to a global reflation trade as the economic data showed improvement in the US, Europe and China. Sectors of the income markets that had done extremely well sold off dramatically, exacerbated by Donald Trump’s win in November.
“Moving into 2017, the bogeyman of income investors is on the horizon – inflation. While we don’t expect inflation to rise dramatically, the market shift away from deflation to modest inflation will be a headwind to most sources of income.
“Simply earning a nominal yield won’t be enough. To preserve wealth, those yields will have to back up enough to compensate for the loss of purchasing power. This could put pressure on all assets, but is even more problematic for fixed income streams.”
Patrick Moonen, senior strategist, multi-asset at NN Investment Partners, points out: “Given the trend we observe in growth, earnings and inflation expectations, we think the best sources of income are real estate and European equities. The earnings prospects for UK companies are strong given the weaker pound and strong commodity prices. This will also protect dividend payments.
“However, given the relatively high payout ratios, we think dividend growth may lag earnings growth in 2017. The reflation beneficiaries are not necessarily the biggest dividend payers, which are found more in the utility, real estate and telecom sectors.”
David Jane, manager of the Miton Cautious Monthly Income fund, adds that while equities remain an attractive source of income, he favours different industries to those that have worked well over previous years.
“The defensive and mature businesses dependent on high levels of debt to pay growing dividends look much less attractive now that interest rates are rising so we prefer previously out-of-favour companies in banking, resources and energy. Property is currently out of favour but may become interesting again in time.”
For investors looking for sustainable income, the key is not to concentrate on just one asset class or region.
Toby Vaughan, head of fund management, global multi-asset solutions, at Santander Asset Management, adds: “With valuations, and hence yields, not compelling across most asset classes, it is important to take a diversified approach to generating yield.
