In today’s low-interest rate, low-yield world, advisers face something of a predicament: investors need to take more risk to generate the same level of income they enjoyed in the past, and the biggest decision for many client portfolios is where that risk should be taken.
Within the fixed income space, there should be little doubt that investing in a flexible fixed income strategy is the way to go. Admittedly, parts of this market continue to defy expectations, but a nimble approach can help investors navigate it successfully.
Partly this is because – after some years of moving in tandem – monetary policy in developed markets is starting to diverge. The US is expected to raise rates in mid-2015, with the UK hot on its heels. In the meantime, the European Central Bank looks likely to undertake further measures, having introduced the purchase of asset-backed securities at the start of September, while Japan continues to undertake monetary easing on an unprecedented scale.
Such policy divergence is likely to create opportunities – in both bond and currency markets – and the more adaptive fund managers should be able to reap rewards.
Even with a more flexible approach, the income available from fixed income investments can at times fail to satisfy some investors. Dividend-paying equities may provide a higher level of absolute income and the potential for capital growth, but with valuations stretched, the potential for a reversal is also of concern.
In a subdued economic environment it is not easy for companies to sustain and grow earnings, but rather than arguing against equities as a source of income, this is an argument in favour of discernment.
With absolute equity yields relatively high, a focus on the reliability of yield is important. Looking at a company’s operating return on investment can be a means to test this, identifying those companies likely to deliver long-term earnings and cashflows, which in turn can lead to dividend strength. Equally, businesses that have pricing power, and have diversified across different markets and territories, have generally had the ability to deliver sustainable growth even when economic conditions were relatively weak.
Equity dividend payouts are rising in many of the major developed markets. Global dividends reached $288.1bn (£189.3bn) in the third quarter, up 3.8 per cent year on year. In the UK, the $34.6bn paid out in dividends in the third quarter was up just 1.8 per cent, but may have been higher had Vodafone – historically one of the UK’s largest payers – not become a smaller company when it disposed of Verizon Wireless. Data provider Capita Asset Services predicts stronger dividend growth in 2015. Even in the traditionally lower-yielding US market, overall dividend payouts were up 11.4 per cent year on year.
There is no way around the fact investors have to take more risks to achieve a higher income. However, there are ways to ensure risk is well managed and reasonably contained. Flexibility and discernment are key across all asset classes in this environment. A multi-asset strategy can isolate those asset classes that offer the best balance of risk and reward, while at the same time ensuring proper diversification between asset classes.
