The economic backdrop might have improved somewhat but the sustainability of this is less certain, causing great consternation for investors. As a result, their behaviour has the potential to swing from risk seeking to risk averse in a relatively short period of time, and identifying sources of consistent investment returns can be extremely difficult.
Historically low interest rates do not help matters either. Investors are, quite deliberately, not being rewarded for holding cash as developed market governments attempt to nurse their economies to a better state of health.
With UK equities currently yielding more than UK gilts, a credible case for income derived from equities can be made at present – in spite of the stockmarket’s impressive start to 2012. In the long term, compounding makes companies that offer growing dividend income particularly attractive.
Indeed, studies have shown that, if dividend reinvestment is stripped out of overall returns in the past 60 years, then the return from equity markets is lower than that from bonds. While the UK has traditionally been associated with paying high dividends, other countries have started to embrace shareholder value and it is increasingly companies in Asia, Europe and the emerging markets that are using earnings to return dividends to shareholders.
For equity income investors, there is also the reassurance that corporate balance sheets and earnings have been reasonably robust in spite of the difficult economic conditions.
It is important to recognise the potential income benefits from broad asset classes. In the ‘alternative’ sphere, property and infrastructure investments are two good examples of alternative sources of steady investment income, although investors may have to withstand a degree of illiquidity, particularly in real estate investments.
The increasingly diverse nature of fixed income, however, means that it should not be written off merely on the basis of seemingly overvalued government bonds. If global growth stutters or the eurozone crisis flares up yet again, core government bond yields, such as UK gilts, will likely stay anchored at their low levels or could even fall lower.
Furthermore, there are potential opportunities in other areas of fixed income, for example in selective corporate bonds, including high yield, in which many companies are actually in strong financial health and default rates are predicted to remain relatively low. Alternatively, emerging market bonds remain untapped territory for many UK investors.
Given the expanding fixed income universe, a popular way for investors to manage their fixed income exposure has been to delegate allocation decisions by utilising strategic bond funds.
However, in-house research has identified that such managers have tended to gravitate toward developed markets; emerging market bond exposure is all but overlooked, with the weighted average of the top-10 strategic bond funds – by AUM – allocating less than 3 percentage points to this area.
Asia and the emerging markets are likely to drive future economic growth. Their dynamism, supported by burgeoning middle classes and healthy public finances, will ensure an economic power shift away from the so-called developed markets.
This trend should secure continued flows of international money as well as ensuring substantial domestic development and investment which, over the long term, should support their stock and bond markets.
