Investors who require income are facing the same principal challenge as growth investors. The combin...
Investors who require income are facing the same principal challenge as growth investors. The combination of new technology, telecommunications and the internet is transforming business and consumer behaviour.
As in the previous industrial revolution this is producing strong deflationary fires. At the macro level the best evidence can be seen in the US where despite the unprecedented length of the current expansion, inflation appears to remain dormant.
At the micro level most industries are starting to show the effects. This is clearly evident in the banking industry where new entrants to the mortgage market, such as Standard Life, do not have the cost base of the bank network and have been able to take a significant share of the new mortgage market.
In retailing, the consumer is becoming used to the idea of using the internet to check prices. Even in the service economy, signs are beginning to appear with Royal & SunAlliance closing a data input facility in Liverpool with the work being transferred to India.
There are two main consequences of this background for income investors. Firstly this deflationary background and the ability of new entrants to enter markets using new technology, means that there is constant pressure on selling prices and hence margins. In many instances forecasters are being optimistic as to future levels of profitability. Management of companies react to falling profits by becoming more aggressive in cost cutting and many forecasters expect that businesses will be able to recover to former margin levels as action works.
However the pressure on margins will be ongoing and in many businesses historic margin levels are unlikely to be seen again. This means that investors are going to be disappointed by future profit and dividend levels and will mean that many traditional equity income investments will continue to disappoint.
Secondly, in a period of very low inflation, genuine growth will become increasingly valuable but will also come with increased risk. Investors' reaction to the situation when a growth company becomes unstuck is savage.
The more successful funds have been investing in both growth and income stocks. This strategy has worked well providing superior capital performance. It has also benefited the dividend payable on the fund by taking profits on the growth holdings and purchasing further income shares.
I found this to be most marked in February and March and, with the benefit of hindsight, the prices paid for some income shares has proved very attractive. In many cases these shares have generally performed well which means that funds have continued to perform well as sentiment in the market has swung between the old and new economy.
Square Mile’s series of informal interviews
'An entirely different beast': How have emerging markets, Asia and Japanese equities evolved over the past decade?
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Spent 20 years with Aviva
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