How does global equity income fit into a retirement income portfolio?

The problem is finding a steady source of income in a low-interest, low-yielding environment.

Several factors are conspiring against those seeking an income at the moment, one of which is the rising threat of inflation – an inflationary environment tends to eat away at any income.

“Inflation has been consistently rising over the last three months, which will squeeze the living standards of retired people living on a fixed income, particularly as they often spend a disproportionate amount of their income on fuel, food and heating”, notes Vince Smith-Hughes, retirement expert at Prudential. 

The outlook for fixed income is also proving problematic, as those who previously relied on the asset class to meet their income requirements can no longer do so.

Global equity income is important because diversified income helps protect retired investors from specific company risks as well as specific country risks. Adrian Lowcock

A report published in February by MetLife, called Guaranteeing Real Pension Freedom, highlights nearly six out of 10, or 57 per cent, of over-40s worry that low long-term interest rates are making retirement saving more difficult, while 52 per cent voiced concerns about not having income certainty in retirement.

The Iress Retirement Income Report sets the scene: “Low interest rates will remain a factor, with the latest Bank of England Bank Rate cut to 0.25 per cent in August 2016, possibly not the last in this current run of monetary policy.

"Gilt yields also face an uncertain period as the negotiations for Britain to leave the European Union begin in earnest in 2017.

“The prolonged spell of low interest rates has had a profound impact. Choices made by savers, investors and advisers have been shaped by the search for yield, particularly for those already in retirement.

"Add in the volatility that stockmarkets inevitably endure from time to time, and you have a challenging environment in which to meet and manage individual retirement expectations.”

Diversifying dividend growth

Global equity income may provide part of the solution. Adrian Lowcock, investment director at Architas, explains: “One of the key issues in retirement is inflation proofing your income – getting an income which can grow as prices rise. 

“Fixed income does not offer this, nor does cash. Equity income can offer capital growth and rising dividends.”

He notes: “Global equity income is important because diversified income helps protect retired investors from specific company risks as well as specific country risks. The more diversified the portfolio, the better as it reduces the possibility of investment shocks hitting the market.” 

With more regions, such as Asia, encouraging corporates and large companies to pay dividends as part of wider corporate governance improvements, the reliability of this income stream makes it well suited to a retirement income portfolio.

The key is investing for growth, as this will ensure those preparing for retirement will have access to a pipeline of income, even while long-term structural growth is likely to remain low, Andrew Wheatley-Hubbard, manager of the BlackRock Global Equity Income fund, suggests.

He notes this type of income can be found among high quality companies which can grow revenues, cashflows and dividends thereby offering real growth, regardless of the macro environment.

Clients remain concerned about political and economic risks but clients need equities for growth. High quality companies can provide equity exposure with less volatility.Andrew Wheatley-Hubbard

“This growth is important in building a retirement plan – we know yields in traditional fixed income products are low today, but in real terms they will continue to decline,” Mr Wheatley-Hubbard points out. 

“If planning for a 25-year retirement, 3 per cent inflation will erode half the purchasing power. Given the starting yields are lower even after the recent rise - 10 years ago, the US 10-year was yielding almost 5 per cent compared with 2.4 per cent today - clients need to consider other sources of income.

"High quality equities with predictable and sustainable cashflows can offer an attractive, reliable income stream to clients.

“Finally, clients remain concerned about political and economic risks but clients need equities for growth. High quality companies can provide equity exposure with less volatility", he adds.

The low volatility aspect should offer some reassurance to those saving for retirement.

Keeping volatility low

Nick Dixon, investment director at Aegon, agrees volatility is a key consideration as prospective retirees face a dilemma around maintaining spending power while inflation rises.

“Part of the solution lies in avoiding ‘return-free’ government bonds and using low volatility equity dividends as a core component of income planning,” he says. “If the bulk of income comes from natural yield, capital volatility can become less important in the investor’s aggregate risk profile.”

The emphasis is on sourcing income from across the globe though, as opposed to relying on one or two regions.

The higher the yield, usually the higher the risk and the last thing you want in retirement is to see your income cut if unsustainable levels of dividends leads to them being cut or even stopped.Darius McDermott

Chelsea Financial Services' managing director Darius McDermott says this adds diversification.

“There is more choice of stocks, less reliance on any one economy for earnings and therefore dividend growth and managers have the opportunity to really hunt down and find the dividend growth of tomorrow,” he suggests.

Within a retirement portfolio he stresses the need for investors to look past the highest paying yields and focus on where they can find growing yield.

“The higher the yield, usually the higher the risk and the last thing you want in retirement is to see your income cut if unsustainable levels of dividends leads to them being cut or even stopped,” he cautions.

Global equity income may not be suited to every investor saving for their retirement and the best way to understand its suitability is to go to a financial adviser.

Colin Morton, manager of the Franklin UK Equity Income fund, notes: "Equity markets aren’t without risk. Obviously they’re not for everybody.

"The advantage of putting your money in a bank or building society or buying a bond is, all things being equal, you know you’re going to get a yield - ok very low [yield] but you know you’re going to get it and you know you’re going to get your money back at the end of it."

He explains: "With the equity market you’re getting a higher yield but the risk is with your capital. Now, as we all know, over the longer term the capital from the equity market has tended to do much better than the capital from putting your money in the bank or building society but of course there’s no guarantee that’s going to happen and that’s obviously the thing of which everyone should be a bit cautious."

For those who have decided a global equity income investment is appropriate for them, several studies indicate dividends and reinvested dividends generate a significant proportion of the total return from equities over time, as Andrew Jones, global equity income fund manager at Henderson Global Investors, points out.

“Investing globally for income has significant diversification benefits from a market concentration viewpoint and also allows access to a far wider range of dividend paying companies.”

eleanor.duncan@ft.com