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.
High Yield income:
The headline attraction for including high yield (HY) corporate debt in an income-seeking portfolio is clearly the favourable yield of the asset class. Given the expanse of the HY universe, there is plenty of opportunity to create a well-diversified HY basket, yet achieve high aggregate yields.
Indeed, while individual assets within the class may have material company-specific risk, these can be mitigated, but more importantly, diversified away in an appropriately constructed basket.
Another positive aspect of HY is the nature of its relationship to other fixed income asset classes. In a structural environment that is unlikely to favour assets with a significant relationship to interest rates, it might appear as if all fixed income asset classes would be disadvantaged.
However, this is not the case. Whilst historically correlations between corporate debt in aggregate (HY and investment grade) and government debt has been high, correlations between just HY and government debt have been zero or negative depending on the time period.
These figures underline the point that HY is very much a set of assets dominated by credit considerations, rather than interest rates. In this respect, value in HY can be thought of as primarily a function of the health of corporate balance sheets, given the macroeconomic environment.
The business climate is clearly of importance in ascertaining to what extent the robustness of any firm’s financial health will be tested. Historically, modestly negative or low positive growth environments have tended to favour exposures to corporate debt.
In addition, in all but the very worst recessions, not only is the relative performance of corporate debt far superior to that of equities, but is generally positive too.
Emerging market debt income:
Emerging market debt has traditionally not been included in income-centric portfolios used by UK investors. Part of this relates to the historical under-development of the asset class and, quite simply, there were more familiar income opportunities; there was little need to look further afield.
Today the asset area is supported by the fact that the fiscal positions in emerging markets are far more favourable than many developed economies. They are not suffering under huge debt burdens, have attractive growth levels and are able to offer attractive yields. In addition, many emerging economies are commodity rich and have favourable demographics.
We think that adopting a blended approach to investing in EMD (encompassing local currency, hard currency, and corporate debt) is the optimum way to target income. A blended approach provides investors with exposure to all the main drivers of EM growth and the diversification lowers the overall volatility, and average returns have historically been very attractive
A Multi-asset approach
The three opportunity sets discussed above – established dividend paying equities, high yield corporate bonds and EMD – have their own features that make them attractive as sources of income-intensive returns. We believe that applying a diversified multi-asset approach to this broad opportunity set can avoid the tail-risks associated with single asset class approaches.
The ability to adjust nimbly to a volatile investment environment is arguably more important now than ever. And this certainly applies to income-centric investments. With the potential that business cycles could be more frequent and recessionary environments a more persistent risk, the investment architecture to deal with this is not commonly found in income vehicles that previously succeeded in a higher growth world.
The world remains one where income is necessarily a crucial component of most investors’ arsenal – but accessing this necessitates an new approach. A flexible and diversified multi-asset income approach could be a compelling solution.
