What is the ‘new normal’ for income?

In the wake of the global financial crisis, central banks around the world sought to support economic growth through the use of monetary policy. In the largest and most prominent developed economies, this included sharp cuts to interest rates, with many falling close to zero, combined with unprecedented levels of quantitative easing (QE).

At the time, this was a new monetary policy experiment and nothing on this scale had been attempted before. While the policy was unprecedented, many market participants predicted it would not be long before positive economic growth underpinned a recovery in inflation and interest rates would again start creeping higher. More than a decade later, while interest rates haven’t fallen much further, the experiment is certainly not over as monetary policy is far from returning to the ‘normal’ levels seen pre-crisis.

For borrowers and consumers the current ‘lower for longer’ environment has been great news, with governments and corporates alike issuing debt at relatively low cost and households able to enjoy reduced rates on their borrowings, which has helped fuel consumption.

The income dilemma

However, for savers and those seeking income, particularly in retirement, the low interest rate environment has made it much harder to source a sustainable income from traditional sources such as bonds and cash.

For example, the yields on an increasing number of 10-year government bonds are now negative, including France, Germany, Japan, Switzerland and the Nordic countries. While in the UK and the US, 10-year government bond yields remain positive at 0.66%* and 1.71%*, respectively, this is a significantly lower yield than savers would have received in the past.

From a cash point of view, while 2018 saw many central banks increase interest rates, this was certainly short lived. The direction in 2019 is once again downwards, with the US Federal Reserve cutting its Feds Fund Rate by 0.25 percentage points in July, September and again in October. The July move was the first interest rate cut since 2008 and followed four increases in 2018. With slowing US growth, sluggish inflation and ongoing trade tensions, the US Fed is coming under increasing pressure from both external sources, such as President Trump, as well as its own ranks to make more aggressive rate cuts.

Emerging market equities are often overlooked as a source of income.

This presents income investors with a serious dilemma, as the hunt for better returns, or yields, means investors are having to expand their search beyond traditional sources and find new investment ideas. However, this inevitably means moving further up the risk ladder to a level, perhaps, investors may not be comfortable with.

In such an uncertain environment, there is unfortunately no silver bullet solution to delivering a reliable and sustainable income stream at a low level of risk.

There is, after all, no such thing as a free lunch! But that’s not to say there aren’t ways that investors can try and mitigate some of the challenges of the ‘new normal’ that we find ourselves in.

Meeting the challenge

Diversification is a word that crops up time and again, however with very good reason. Investing in a broad variety of assets, across different regions with varying characteristics, can not only help spread the investment risk, but also provide multiple income streams and return drivers. This will allow your portfolio to adapt to any unexpected events and create the right balance between risk and reward. This is especially important for those looking to provide an income through their retirement years that could potentially have to last decades and perform throughout many market cycles.

UK equities, government bonds and cash may have been the mainstay holdings of an income portfolio in years gone by, and while there are still income benefits to these assets, the savvy investor looks to expand their horizons both geographically and in terms of the types of investment.

Emerging market equities are often overlooked as a source of income. However, it is an asset class that is becoming increasingly hard to ignore. Emerging markets not only provide exposure to the world’s largest populations and fastest growing economies, but the asset class now also gives investors access to some of the world’s most successful companies, which are becoming increasingly shareholder friendly.

The latter is the most interesting for income investors today, particularly as these companies are more likely to reward their shareholders through the payment of dividends, providing a direct income stream. As with any asset class, there are of course many factors to take into consideration, including the current global economic slowdown and tensions on trade. However, with a comparatively low dividend pay-out ratio of 43.6%* for the MSCI Emerging Markets index, compared to the 79.8%* offered by the UK’s FTSE 100 index – emerging markets provides a significant opportunity for dividend growth and so a very positive outlook for tomorrow.

Income investors can also spread their search in terms of the type of investment within an asset class. Alternatives provides a unique opportunity for investors to achieve this with a broad range of investments on offer including renewable energy, private equity and infrastructure. These investments all have interesting and very different return profiles that could fit into a well-diversified portfolio, alongside old favourites such as real estate and UK equity income funds.

In the current environment where interest rates look set to remain lower for longer than people might think, investing for your future income needs has become a fine balancing act.

Investors therefore need to be confident that the right mix of assets are in place to meet their objectives. A diversified multi-asset portfolio that blends a number of different asset classes and exposures, seems well placed in this current environment.

The low interest rate environment has made it much harder to source a sustainable income from traditional sources such as bonds and cash.

For further information on the Quilter Investors Monthly Income range, please click here.

*Source: Bloomberg as of 1 November 2019

For Investment Professionals only. Past performance is not a guide to future performance and may not be repeated. Capital at risk.

This communication is issued by Quilter Investors Limited ("Quilter Investors"), Millennium Bridge House, 2 Lambeth Hill, London, England, EC4V 4AJ. Quilter Investors is registered in England and Wales (number: 04227837) and is authorised and regulated by the Financial Conduct Authority (FRN: 208543).

For further information and to access the KIID and prospectus for the Quilter Investors Monthly Income and Quilter Investors Monthly Income and Growth Portfolios, please visit the Quilter Investors website.

This is a Quilter Paid Post. The news and editorial staff of the Financial Times had no role in its preparation.