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Yield drop puts equity income under more pressure; Portfolio hedges face new challenges

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Sustainable income

The hunt for income is becoming ever tougher. Wealth managers’ own portfolios, as we’ve examined in recent months, are now yielding less than ever before. On a trailing basis, the typical balanced offering provides little more than 1 per cent, and even some income portfolios now offer less than 3 per cent.

Bond yields may have moved a little higher in recent months, but the main factor in this shift - the collapse in dividend payouts seen last year - has yet to materially alter. Those cuts are still filtering through: as analysts at SocGen note, the MSCI World dividend yield has fallen to less than 2 per cent in recent weeks. The UK market stands relatively tall by contrast, still offering a payout above 3 per cent. For those who are going global, the pickings are getting slimmer.

It’s not all bad news: many of the biggest cuts of last year came from financials, which numerous equity income funds have long avoided.

But looking ahead, one of the biggest challenges will stem from the active industry’s ESG push. How long will equity income strategies be able to resist that drive? The answer is probably ‘longer than many expect’. But be that as it may, those investors looking for income with a sustainable slant will likely have to accept even lower payouts in the interim.

That’s because it’s not just resources companies that are up for debate in this context. In SocGen’s words, “the real challenge comes from reducing carbon, as utilities traditionally pay big dividends”. Squaring these ever more complicated circles will make life even tougher for some income managers in the years ahead.

Gold back in the fold

One part of the market that’s done particularly well in the six months since the first vaccine efficacy announcement is energy. Look at the 10 best performing strategies in the IA universe over the past half year, and five of the top six are energy-focused.

But while it’s been quite the return to form for commodities, not all have flourished. The worst 10 funds over the same period are – aside from the odd idiosyncratic entry like Legg Mason Japan – almost all gold strategies.

Inflation anticipation may be back in investors’ minds, but it’s the prospect of recovery beforehand that’s knocked bullion. We’ve previously discussed gold’s dual purpose, as a hedge against both deflationary and inflationary pressures. But an environment in which growth is only just getting going hasn’t proven much help.

Some are now looking more closely at the precious metal once again. Ruffer, which hit the headlines last year for swapping some of its gold holdings for bitcoin, has changed course somewhat in recent weeks. Having begun selling down that exposure as soon as February, the fund house said this morning it had added to its gold and gold mining positions over the past couple of months.

More notable still is its view on bonds: the managers believe the “next leg down for conventional bonds” could be driven by Europe, not the US, as growth surprises in the former start to pick up. With 10-year bund yields having ticked higher last month despite Treasury yields falling, it may be that this dynamic has already begun.  In any case, the next six months could prove a little thornier than the past half year.

On the charge

In late 2017 Fidelity caused a mild stir with its announcement of a ‘fulcrum’ fee model: charges of 0.65 per cent would move 20 basis points in either direction depending on how well its funds performed.

At the time, that move caused more debate about how active fund fees could move with the times. The truth, however, was that there was little appetite for such innovations – and Fidelity is now scrapping those share classes as a result.

Ultimately, the direction of travel on fees remains simple and to the point: lower, not more complicated, remains the way to go. Those holding the line on costs are nowadays more likely to look at different investment styles, like ESG, rather than attempting to innovate with fee structures.

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