Investment Income CPD Course  

Using alternative income streams within a portfolio

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Understanding current trends in income

Using alternative income streams within a portfolio

Equities and bonds have become highly correlated, which means they tend to react to market moves by moving in the same direction, whether to the upside or downside.

At the same time, the yield on offer from traditional income assets is as low as it has ever been.

This is largely down to the role central banks have played and it is an environment that has left income managers chasing alternative sources.

Andrew Morgan, portfolio manager of Alpha:r2 at Walker Crips, explains the “increasingly desperate” hunt for income can be traced back to the distortion in markets triggered by quantitative easing (QE), resulting in boosting asset prices and compressing yields.

“As a result, many investors see regular equities and bond markets as overvalued, and are disappointed by their income levels. 

“Investors also worry about what will happen as QE unwinds: with interest rates close to zero, bond capital values are likely to be hit as rates normalise,” he predicts.

Andrew Herberts, head of private client investment management at Thomas Miller Investment, says: “As central banks have kept interest rates low, investors have been forced to look beyond traditional assets to maintain income at historic levels. 

“We can argue whether searching out income per se is an efficient investment strategy, but the fact remains that a significant proportion of investors are focused on income. 

“Since the global financial crisis, asset prices have risen and accompanying yields, not necessarily absolute payouts, have fallen.”

Many fund managers are being forced to look beyond the traditional asset classes to meet income requirements, and other targets, in their portfolios.

One of these is Matthew Yeates, investment manager at Seven Investment Management, says this includes investing in assets such as gold, infrastructure and option strategies.

He confirms: “We are looking more broadly because we don't have the same confidence bonds will continue to play the role they used to in portfolios while yields remain so low. 

“This is from the perspective of income, but that's only half of it – if inflation fears continue and the risks of a taper tantrum rise (where equities and bonds fall at the same time over fears of rising rates) they are unlikely to provide the diversification to equities regardless of the currently small income they provide.”

Alternative risks

Anthony Rayner, co-manager of the Miton Cautious Monthly Income fund, acknowledges the increasing popularity of alternatives in a world of low income and high correlations between asset classes.

But he also warns of three possible risks:

  • Equity beta risk.
  • Interest rate risk.
  • Credit risk.

He insists: “Alternatives are simply made up of these risks under a different label, and therefore shouldn’t be expected to provide material diversification.”

But surely being in risk assets will help beat inflation, which has settled at around 3 per cent in the UK?