The income dilemma
Yield is fast becoming the holy grail of the 21st century. 10 years ago, you could still sign up to a 12-month fixed term cash account and get a rather splendid 10% pa income from your investment. Today you are lucky if you get 1%.
- The hunt for yield is one of the key investments problems of the age
- High yield bonds and equities have their limitations; income alternatives and absolute return bond funds need careful vetting
- A key question is whether the level of income sought is realistic given the income from cash
Income investments with no income
Bonds are little better and potentially a lot worse. In 2015 Switzerland became the first country to sell 10-year bonds at a negative yield – followed by Japan in 2016. Investors basically paid a fee to lend money to these governments for a decade – and were 'happy' to do so! They both now have a positive yield all of 0.1%! As Bruce Stout, manager of Murray International Trust PLC, commented recently: “This type of distortion serves only to highlight just how incredibly far the world has shifted from economic orthodoxy when savers expected, and were entitled to, a return on their savings.”
Or to look at it another way you are getting return free risk, especially if bond yields continue to rise from this historically low base.
What income can be found?
Sticking with fixed income for a moment, high yield bonds – which we used to call 'junk' – are one option. Oil infrastructure projects and a host of high yielding products abound, but at what risk to an investors capital?
Then there are the bond 'proxies' which have attracted more money than is perhaps justified – not just the utilities companies, but also property. Are property values also getting stretched again? And are investors worried about being "gated" and unable to buy or redeem units as was the case for many funds last year?
There are high yielding equities, but value traps are plentiful. The market yields significantly more than the government bond market, but if bond yields rise, we could see the return of the reverse yield gap.
Going global for dividend-yielding companies has some attraction still. Asian and Japanese markets are providing higher dividend pay-outs these days, but beware the additional risk and currency fluctuations.
There is a proliferation of income alternatives and absolute return bond funds, but they require careful vetting and may not meet suitability criteria.
So just how do you invest for a cautious client requiring income these days?
All these options are a long way from the relative safety of cash and you must ask, is the level of income being sought realistic today, given the clients attitude to risk and tolerance for loss? Probably not, but that makes for a difficult conversation. The only way to mitigate some of these risks is to be as diversified as possible and find a fund manager that can pick the right stocks or bonds.
"There are high yielding equities, but value traps are plentiful. The market yields significantly more than the government bond market, but if bond yields rise, we could see the return of the reverse yield gap. "
Immediate outlook
Even though both equity and bond markets look expensive right now, it is still possible to differentiate between whether a business or bond is cheap or expensive, and whether it is quality or not. Equities have an edge in terms of income, which makes them preferable to bonds in the main and corporate bonds are more attractive than sovereign debt.
For the long-term investor, a value driven equity approach such as that followed by Schroder Income makes sense, or there is always the attraction of the revenue reserve of investment trusts; City of London has a 50-year dividend growth track-record and a current yield of almost 4% for example. And perhaps bond funds driven specifically by credit risk with duration, rate and currency risk hedged away like GAM Star Credit Opportunities.
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Clive is a director of FundCalibre, a fund rating agency, www.fundcalibre.com and managing director of Albemarle Street Partners www.aspllp.com providing investment consultancy services to IFAs and the fund management industry with experience gained over a 37 year career.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Clive's views are his own and do not constitute financial advice.
