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Investment Insight: The evolution of income

It is time to adapt and evolve to survive and prosper

Once upon a time, you used to be able to save your spare cash into a savings account that would pay you an interest rate above inflation, giving you a real return on your cash. Sounds like a fairytale, doesn’t it? Those days, as we all know, are but a dim and distant memory. Earning a decent yield these days – without compromising the capital that you are investing – involves a bit more thought and taking different risks.

If we look back 10 years, the typical multi-asset income portfolio would have roughly needed a 60/40 fixed interest/equity split to give a yield of 4.5 per cent. Nine years of quantitative easing has driven the yield on traditional risk assets such as cash and bonds to staggeringly low levels. If we use the Markit iBoxx GBP Liquid Corporate Large Cap index as a proxy for investment grade corporate bonds we have seen the return falling from 8 per cent to around 3 per cent.

At the same time the risk, as measured by the duration or sensitivity to interest rate change, has increased, rising from seven- and-a-half years to nine years. With this in mind, it has been time for a rethink and to evolve the way you achieve natural income. As Darwin pointed out, it is those that adapt that actually survive and prosper.

Methods of survival

One method is to consider alternative income-producing assets that yield, will float up in a rising interest rate environment and are higher up the pecking order if things go wrong. Examples include asset lease financing, asset-backed securitisations and other vehicles that are stepping in to lend money to businesses at a time when the traditional financiers are compromised due to the regulatory hurdles. There is a cost to this, of course. Different risks must be considered. These are – in the main – illiquid assets, so should only be bought in closed-ended form. This means investors can suffer the vagaries of price movement on sentiment, even if the NAV/value of the underlying assets does not actually change.

Income is available – investors should broaden their mindset and work a bit harder to find it

Greater heed should also be paid to the yield available in emerging debt market. There has been a lack of yield compression in this most-doubted of asset classes relative to their developed cousins, and recent moves provide a potentially decent entry point. Yes, this is a volatile asset class, but you are getting paid to take the risk if you pick the right manager who can see through market noise and spot opportunities.

Big changes in a decade

There has also been a change in the income available in the equity markets which should not be forgotten. A decade ago, there were only 10 global equity income funds available compared with 44 now. Corporate governance improvement in Asia, specifically Japan, Europe and emerging markets have meant a much greater propensity for companies to return cash to shareholders, making these viable markets to invest if you need income.

There are some key take-outs in all of this – the vital one being that income is available, so investors should broaden their mindset and work a bit harder to find it. At the same time, volatility is going to potentially increase in the capital base that investors are earning your income from. The crucial point here is that if you have a natural income producing asset that you do not need to draw from at the capital level. This volatility is incidental, and in the long run it is positive as active managers pick up great debt and equity at cheaper prices.

Kelly Prior is investment manager in the multi-manager team at BMO Global Asset Management 


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