Diversifying for a sustainable income

On top of this, investors have to contend with an environment of geopolitical uncertainty, from Brexit to trade tariffs, slowing global economic growth, not to mention the volatility caused by central banks starting to normalise policy. But whilst the news headlines may be less optimistic from a macroeconomic viewpoint, there are still plenty of income investment opportunities, providing you know where to look.

^{Source: FactSet financial data and analytics/MSCI*}

A globally diversified approach allows investors to look elsewhere in the search for income, which can have numerous advantages.

For example the UK equity market remains a good hunting ground and we saw dividends rise 5.1% here in 2018 to a record £99.8bn. However, investors should be mindful of where these dividends are coming from. Beneath the headline figures just five companies accounted for 34% of the total dividends last year, and the top 15 companies accounted for 58%. In addition, UK dividends are concentrated in the largest companies, with the small and mid-cap stocks in the FTSE 250 index accounting for just 11% of the total dividends last year. And past experience from the financial crisis, during which time financial stocks were the biggest sources of income, shows the risk such concentration can present.

While the UK stock market will always be an important source of income for UK investors, it is not the only one, and with the Brexit uncertainty continuing to be a primary risk in 2019, it pays to look beyond the traditional big earners. 

A globally diversified approach allows investors to look elsewhere in the search for income, which can have numerous advantages. Asia is traditionally relatively unfavoured by income managers but that is beginning to change. In the past, firms in the region have re-invested the vast bulk of their profits, in order to fuel growth, with shareholder pay-outs being few and far between. But we are now beginning to see a strengthening in the shareholder lobbying power in the region, and greater pressure on firms to reward their investors as a result.

It is also important not to overlook Japan, where we are seeing corporates benefit from Prime Minister Shinzo Abe’s business reforms, part of the so-called ‘Three Arrows’. Fewer companies are hoarding cash on the balance sheets and are instead choosing to return cash to shareholders. Interestingly Japanese equities now yield more than their US equivalents and there is potential for further progress to be made in this area.

However, it is important to note that income is not equity specific. It may play a big part in many portfolios, but a key advantage to a diversified multi-asset portfolio is the ability to seek income generating investments across regions and asset classes. Be that emerging market debt, high yield bonds, infrastructure assets or even alternative asset classes such as renewable energy.

A blend of asset classes allows multiple sources of income as well as multiple performance drivers, with the diversification benefits helping to provide a sustainable income as well as mitigate idiosyncratic risks.

It is not just this huge variety of choice, however, that makes a diversified multi-asset portfolio a strong choice for income. The flexibility of these portfolios means managers are not forced to invest in asset classes where the risk-reward trade off looks unattractive. If for example US high yield starts looking overvalued a manager could remove the exposure and switch to something more attractive. An unconstrained remit allows these portfolios to be positioned for long term themes and trends, whilst allowing them to be nimble enough to adapt to unexpected market events if necessary.

As global growth continues to decline, with China having posted its slowest annual expansion since 1990, sources of sustainable income will continue to be sought after, and the benefits of a globally, diversified and uncorrelated portfolio will become ever more apparent.

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