Income-producing alternatives step up

Paul Flood, lead manager of the Newton Multi-Asset Income fund, points out: “The impact of quantitative easing and zero-interest-rate policies has resulted in depressed prospective returns from bond markets with very little in the way of protection against inflation. So infrastructure-related assets are in high demand.”

He explains: “Infrastructure assets tend to have a significant proportion of their revenues fixed and inflation-linked, with very little exposure to the economic cycle. This provides two great characteristics from a portfolio construction viewpoint. First is diversification. Second, direct inflation protection is an attractive proposition in a world where increased emphasis is being placed on getting back to central bank inflation targets and governments around the globe talk about a shift from monetary expansion to fiscal expansion. 

“This points to increased spending on dilapidated infrastructure.”

Property is a little more challenged if yields continue to rise, which we think they may, and in those circumstances we would anticipate some under-performance against more cyclical parts of the equity marketJohn Stopford, Investec Asset Management

Peter Webster, assistant fund manager on the Henderson Alternative Strategies Trust, adds: “It is no coincidence that as yields on traditional assets have fallen, the universe of income-producing alternative assets has grown sharply.”

He continues: “Investors have shown strong appetite for infrastructure-focused vehicles over the past 10 years. Eleven trusts have launched into the closed-end sector during that period and now have a combined market cap of almost £11bn. Demand has been driven by the long-term nature of the cashflows, the fact that the credit risk often lies with a local authority or other government agency, the fact that cashflows are often inflation-linked and the yield pick-up over gilts.” 

Mr Flood also points to renewable energy infrastructure assets as an attractive source of income, as they tend to have 50-60 per cent of their revenues backed by government subsidies, which are fixed and inflation-linked, with support from the Renewables Obligation. 

“With prospective annual returns in the range of 5-9 per cent, one can appreciate the appeal of infrastructure-related assets,” he concludes.

John Stopford, head of multi-asset income at Investec Asset Management, agrees infrastructure offers a low correlation to equity, as well as generally high asset quality and an element of inflation protection, but notes “valuations are stretched given a lack of supply”. 

He says: “Property is a little more challenged if yields continue to rise, which we think they may, and in those circumstances we would anticipate some under-performance against more cyclical parts of the equity market. Valuations, however, are reasonable and we expect to see rental growth over the next one to three years.”

Eugene Philalithis, portfolio manager of the Fidelity Multi Asset Income fund, notes while property can be an income source, “it is vulnerable to rising interest rates. Physical property funds can also face liquidity issues, as investors saw post-Brexit. Where [our] multi-asset funds do invest in property, we mainly use Reits, which are more liquid and help us to efficiently manage our portfolios.” 

Instead he highlights other asset classes uncorrelated to bonds or equities that can generate income, such as aircraft leasing products. “These lease aircraft to airlines, generate a yield for investors, and then sell on the aircraft in future. The yield is around 8 per cent – very attractive in the context of a diversified alternatives portfolio and diversified fund more generally.”

Mr Webster notes investors are attracted to aircraft leasing by the uncorrelated source of income that these assets generate. But adds: “The risk within these investments often comes from the asset and counterparty concentration where often only one or a few assets are owned and leased to just one counterparty.”  

He points out direct lending has been another alternative source of income for investors, with investment trusts in this area either lending directly to small and medium-sized enterprises or to lending platforms that, in turn, lend to a pool of retail or corporate borrowers. 

“Direct lending vehicles tend to offer higher yields than most traditional investments,” he explains. “We feel that the underwriting ability of management teams is key within this area and that as interest rates and default rates increase, the models will be more severely tested.”

This year may be nearing its end, but investors searching for sustainable sources of income could do well to look into more unusual areas again in 2017 – providing they are willing to do the research.

Nyree Stewart is features editor at Investment Adviser