Once upon a time, such a portfolio could have contained UK or US government bonds with a secure income and a yield of 3 per cent or more, combined with a reliable equity income yield from regular dividend payers such as companies in the oil and financial sectors.
But with the UK 10-year government bond yield currently sitting at less than 0.3 per cent, and many of the traditional dividend-paying companies cutting or cancelling their payments, the road to a reliable income for clients has never looked rockier.
Wayne Berry, investment manager at Brewin Dolphin says the changed world in which we live means one of the historic rules of investing, which is to not pay income from capital gains, may have to adjust, too.
He believes with bond yields at very low levels, and equity markets generally rising and thereby generating strong capital gains, paying income from those gains is the way forward.
Income can easily act like the fabled sirens luring many an investor onto the rocks to sink their portfolio.--Will McIntosh-WhyteLooking for income
Others are taking different routes. Peter Fitzgerald, multi-asset investor at Aviva Investors, says: “It’s a huge challenge to generate an income in these market conditions; the lower-risk assets don’t have an income yield at all really.
"One of the areas we are looking at is commercial property. We think this is an area where yields are strong, and while there is understandably a lot of concern around the impact of Covid-19 on the commercial property market, not all parts of the market will be impacted negatively.
"On top of this, if employees want more space, or need to be more spaced out at work, that could actually boost commercial property.”
Mr Fitzgerald also uses call options to generate an income. This involves receiving a small payment now which can be used to pay a dividend to investors, in exchange for giving up some of the future share price gains made from a stock.
Stephen Hay, who works on the multi-asset income fund at Baillie Gifford, says one of the ways he has been generating income for clients has been through investments in infrastructure assets.
Many of these derive their income from government revenues, making them particularly durable. In some cases, this revenue is inflation linked, thereby offering additional protection. About 20 per cent of his fund’s capital is deployed into infrastructure assets around the world.
Paul Flood, multi-asset income fund manager at Newton, says he uses alternative income products including infrastructure plays. But he also turns to real estate investment trusts that offer exposure to niche parts of the property market which are likely to benefit from structural changes in the economy.
A balancing act
Ultimately retirees may need to think in terms of cash flow rather than income, living off capital gains and income combined.--Will McIntosh-WhyteJames Mee, who works at fund house Waverton, is similarly exposed to alternative income assets, but invests in the debt of those businesses, rather than the equity.
Balancing income with prudence is an increasingly tricky equation, however.
Dan Kemp, chief investment officer for EMEA at Morningstar, says investors who take on additional risk to achieve a higher yield, are increasing the risk the income achieved will not be sustainable and so be cut in future.
He adds that it is “difficult to see” how a client can achieve a sustainable and attractive income without paying some of this capital.
Will McIntosh-Whyte, multi-asset fund manager at Rathones says: “In our view, when managing any portfolio you have to get the risk right first, and an income portfolio is no different. There is little use in chasing optically high income in the dark and dangerous corners of markets, as when investors experience the inevitable periods of market stress during the life of their investment, the likelihood is you’re taking far more risk to capital than you’d be comfortable with - think mini bonds.
"We won’t go chasing income for the sake of income, and the first judgement is always whether we are being compensated for the risk we are taking, and if the risk makes sense in the context of the wider portfolio. Income can easily act like the fabled sirens luring many an investor onto the rocks to sink their portfolio.
"Diversification is key, and not just among asset classes, but also in the function of each of the assets in a portfolio – what is it there to achieve, and how does it perform in stressed market conditions? Securing a mix of assets that perform differently will ensure enough diversification to weather potential storms.”
He concludes: “Ultimately retirees may need to think in terms of cash flow rather than income, living off capital gains and income combined. Whatever they choose, they are probably going to have to adopt more risk in the future to maintain their lifestyles.”
Many UK investors will see their dividend income shrink by a third or more this year, as half of the UK equity market cuts payouts.--Shoqat BunglawalaRisky affair
Keith Balmer, multi-asset fund manager at BMO GAM, says a major mistake being made by some investors is that they “reach for yield”, that is, take more risk than is appropriate in order to achieve a higher yield.
He feels that a yield of 4 per cent remains attainable without taking excessive risk, and that corporate bonds offer attractive income.
Shoqat Bunglawala, head of global portfolio solutions for Emea at Goldman Sachs Asset Management, is also keen on corporate bonds, and also urges clients to look away from the UK equity market for dividends.
He says: “A-rated US corporate bonds yielded over 4 per cent at the height of the crisis, implying default rates that are more commonly associated with much weaker companies.
"Many UK investors will see their dividend income shrink by a third or more this year, as half of the UK equity market cuts payouts. In comparison, less than 10 per cent of the largest 500 US companies have had to cut dividends to date, [and these cuts have also amounted to] significantly less in value than UK companies.”
But as credit markets have rallied off their lows since March, few such opportunities are still available a few months on. Craig Rippe, who runs a multi-asset income fund at Canada Life Investments, is wary of investing in corporate bonds in the current climate.
He says: “The problem with investment grade corporate bonds, which are the highest quality corporate bonds, is that yields are low, unless you go right to the edge of it, towards the start of the high-yield bond market, and obviously that is riskier.”
Instead, he is keen to invest in some of the equities which have an income stream which has proved durable over time, such as Unilever.
He says: “With Unilever, the yield is quite attractive, and its a yield that will be paid into the future. It is also likely that an investor will get a capital gain from owning those shares over the long-term, though there will likely be quite a bit of volatility along the way.”
