The search for yield always raises the question of how much investors can get from equities versus bonds. The argument that you get a good overall total return from a combination of dividend yield plus capital appreciation from equities is a strong and proven one over time. But there are also times in the cycle when it can pay to have a bigger allocation to fixed income when seeking investments that will give a decent yield.
Close Brothers investment research manager James Davies says the starting point for any conversation is that if you do want a decent yield, government bonds are not the place to be. He says: “If you hold treasuries, bunds and gilts to maturity, you could be nursing a loss there as well. In any income portfolio, corporate bonds certainly have a role to play, as do equities. But at the moment the potential danger is perhaps people might be paying too much for defensive high quality equities. You are seeing high valuations in terms of price to equity ratios.”
Davies believes more value-type equities may be a better option. He says: “People are prepared to pay a premium for quality but from a longer-term horizon, you have to be careful you do not pay too much.” For Davies, investors should therefore be seeking yield from a combination of corporate bonds, high yield and more value-based equity income strategies. Like many of his peers, he tends to cast the net globally when looking at equity income opportunities.
If one looks at the top five funds in the AFI cautious index, four of them are yield-focused vehicles – M&G optimal income, L&G dynamic bond, Artemis income and Newton global higher income. The L&G and M&G funds also make the top five in the AFI balanced index.
Indeed, at the last rebalancing of the three indices in November, a significant number of income vehicles appeared for the first time, highlighting the usefulness of these often more risk- averse vehicles in uncertain times.
Chelsea Financial Services managing director Darius McDermott holds a number of equity and fixed-income funds with an income focus within his AFI portfolios. He says: “We have M&G global dividend. We have for a number of years being diversifying our income options to global equities. We also have bond funds in both our cautious and our balanced portfolios.”
In his AFI cautious portfolio, McDermott says he holds more dividend and bond types of funds. He says: “We also have a little bit of bond exposure via Miton special situations as well as holding equity funds Invesco high-income and M&G global dividend.”
Outside the AFI, McDermott says Chelsea has historically always been into the strategic bond- type of fund. He says: “M&G optimal income is our best-selling bond fund. With Richard Woolnough, we can outsource selection and asset allocation. It gives him the greatest flexibility in respect of duration and asset mix.”