InvestmentsOct 13 2022

Creating a multi-asset income portfolio

Supported by
Columbia Threadneedle Investments
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Supported by
Columbia Threadneedle Investments
Creating a multi-asset income portfolio
(FT Montage/Fotoware)

Those charged with creating income portfolios for clients have, since the global financial crisis, faced a uniquely difficult situation.

In the years between the end of the financial crisis and the advent of the pandemic, the challenge was that few assets offered much of a yield, with the equities that performed best – mostly in the technology space – being those that did not pay a yield.

And in the fixed income universe, a combination of low growth, inflation expectations and central bank bond-buying programmes meant yields reached, and stayed, at historically low levels and in some parts of the world were actually negative.

The story changed more recently, with both bond and equity market yields rising stoutly, but the challenge being that inflation has risen even more quickly, so the real or post-inflation value of the income remains negative. 

Inflation has remained higher for longer. But it’s a rolling series of individual price shocks, rather than the factors that make it more permanent.James Klempster, Liontrust

A longer-term challenge is that clients tend to live much longer now in the decumulation phase than was the case historically, perhaps altering the composition of the assets in the typical retirement pot. 

James Klempster, multi-asset investor at Liontrust, says: “We are in a price shock, inflation has remained higher for longer. But it’s a rolling series of individual price shocks, rather than the factors that make it more permanent.

"So there is a short-term pinch in terms of the income you can get from a portfolio but on a, say, two-year view, inflation will come down and yields will be more attractive.”

He adds: “For the decade after the financial crisis, income-focused clients had to move up the risk spectrum to get income. They had to move to, say, corporate bonds from government bonds or into equities. And that might not have been right for every client.

"But with bond yields rising now, we are very close to the point where US government bonds have a higher yield than the US stock market, and that’s a situation that hadn’t happened for many years. And it represents an opportunity for some income-focused clients to take less risk in their portfolio, if they want to, and still get a decent level of income.”

James Sullivan, head of partnerships at Tyndall, says it is imperative that clients think about an income portfolio in the same way they would a total return portfolio, instead of just focusing on the income generation, as the latter approach risks leaving investors in assets that could decline in capital value.

Have a balance of assets, including some that have low yields now but can grow their yields in future.James Klempster, Liontrust

Keith Balmer, a multi-asset investor who works on the Universal fund range at Columbia Threadneedle, says: “There was a long period of time where income-related funds and assets did well. That ended just prior to us launching our income fund. 

"But the problem with that strong performance from some income products is that it was very concentrated on a small area of the market. Really you had to be invested in growth stocks, and that has unwound in recent times as growth has started to underperform.”

Chasing yield 

In common with Klempster, he says the previous market conditions also forced investors to “chase yield”, that is, own riskier assets. “Many income portfolios that were probably not intended to be very high risk, ended up with significant exposure to assets such as high-yield bonds, and emerging markets." 

He says it is “very difficult to chase yields when inflation is at the current level, but it is best not to just buy the most high-yielding asset. Instead have a balance of assets, including some that have low yields now but can grow their yields in future.

"The other consideration is that people are living longer in retirement. And that may mean they need to own more growth assets in income portfolios – they cannot just degrade the pot of capital by taking income from it. That might have worked in the past, but not now.” 

The problem with that strong performance from some income products is that it was very concentrated on a small area of the market.Keith Balmer, Columbia Threadneedle

In contrast, Kevin Thozet, multi-asset investor at Carmignac, takes the view that some of the traditionally riskier assets are, right now, priced at such a level that they are attractive income investments.

He cited high-yield bonds as an example, saying the yields available are almost double digit right now as a result of the sell-off in the asset class.

High-yield bonds have a credit rating of below BBB, and so are the most likely fixed income instruments to default. 

But Thozet says prices have fallen so far now that a default rate of 10 per cent is implied by the valuations, and this is far below the levels of history, even in periods of economic stress. 

He says that while high-yield bonds are more volatile than those issued by governments, the risk of permanent loss of capital is much lower than has been the case in the past, so clients with the capacity to tolerate volatility may find high-yield bonds attractive.

Seeking growth

David Coombs, head of multi-asset at Rathbones Unit Trust Management, says he has started to invest in high-yield bonds of late as a result of the yields being attractive, but also because the short-duration nature of those bonds means they are less sensitive to interest rates.

In terms of equities, he says investors will shortly start to switch to growth equities and away from value equities. He says the focus needs to be on total return, rather than the highest income, as the latter likely means a capital loss.

He adds the focus should be on companies that are "trading down" or else on the luxury goods companies, as growth is going to be scarce. 

Fahad Hassan, chief investment officer at Albemarle Street Partners, says the other factor to consider with high-yield bonds for income is that, even in cases where the bond holder defaults, historically investors have been able to recover about half of their capital.

When it comes to asset allocation within an income portfolio, Klempster says the time horizon of the client is what matters.

If clients are to spend, for example, 30 years in retirement, then that becomes their time horizon and probably enables them to take more risk.

He says such a time horizon is a relatively new phenomenon for clients with an income perspective, and that may mean the historic assumptions around asset allocation can change. 

He says the key to markets in the years to come will be an understanding that inflation and interest rates are now returning to normal levels, and it was the previous decade that was the outlier. 

david.thorpe@ft.com