John Stopford introduces the Investec Diversified Income Fund which accesses diversified sources of return from across the globe, aiming to provide investors with an attractive and sustainable level of income.
Looking beyond traditional sources of income - a multi-asset approach to income investing
John Stopford, Portfolio Manager of the Investec Diversified Income Fund, discusses why income-seeking investors may need to look beyond traditional sources of yield in order to achieve attractive, sustainable income in the persistent low-growth environment.
The financial crisis has led to a decline in nominal long-term interest rates. UK Gilts, other major government bond markets and cash rates now earn less than inflation. This creates a significant problem for income-seeking investors.
With most income portfolios traditionally relying on these asset classes as an essential source of yield, and government policy measures deliberately seeking to ensure interest rates remain low in order to reduce the debt burden, previously reliable sources of income are unlikely to be meaningfully revived for some time in our opinion.
In a low-growth environment which is likely to persist for some time, we believe that investors should consider a multi-asset approach to sourcing income. As explained here, building a portfolio around three pillars – equity income, high yield credit, and emerging market debt (EMD) results in a very broad opportunity-set, providing income investors with diversified sources of yield.
In particular, it gives the fund manager the flexibility and choice to over- and under-weight allocations as the environment changes with the aim of ensuring a high-quality, sustainable income flow.
Equity income:
There are several advantages to including quality dividend-paying stocks in an income-centric portfolio. The case for quality dividend-paying stocks can be made on two counts.
Firstly, the underlying macroeconomic environment is one that has traditionally seen this set of equities perform better relative to the overall market. Secondly, companies with an established dividend history are in a good position to grow dividends, as balance sheets have improved significantly since the financial crisis.
A diversified exposure to equity income via dividend streams should also provide a form of inflation protection. Over the medium term, successful firms will have a certain amount of pricing power that will be exerted, as underlying costs are passed on to end-consumers.
This ability to maintain an edge over inflationary pressures directly feeds through into earnings. And while dividend payments are not linearly related to earnings, earnings growth is a determining driver of dividend growth over the longer term.
And while income-centric portfolios necessarily focus on yield return, high yielding stocks have historically outperformed with dividends constituting an important part of total investor return. Put simply, yield has proved a simple but effective tool for selecting outperforming stocks.
