Darius McDermott: The search for income solutions

It has been coined the "biggest financial experiment in history" by the likes of Lord Rothschild and others, but more than a decade on from the start of quantitative easing we still do not know its true consequences.

You often read that central banks have never had more power than in the past decade, and that monetary policy has never been stranger, the result being stock markets hitting record highs, only to be undermined by stagnation or anaemic growth in the real economy.

And we only have to flashback to this time last year to remember what happened when central bankers moved away from a dovish policy - it was painful, and the life support was turned back on very quickly.

While the long-term consequences of these policies are not clear, there are a number of warning signs coming through. For example, the 2020s will begin with the lowest interest rates in 5,000 years. It's a startling figure to contend with as central banks globally look to fight any economic downturn. But a decade on from the global financial crisis, there is credibility to the view they are starting to run out of tools to stem the tide.

The growing income challenge is the immediate offshoot of this. I am not going to go into figures about people retiring, but it is clear the number is only going to increase. The search for income has never been harder, particularly for those with one eye on capital preservation.

The past decade has forced investors to move up the risk curve as cash has been a negative yielding asset after inflation and it does not look like investors will be able to go back to cash any time soon.

I recently saw Fidelity Global Dividend fund manager Dan Roberts talk about the challenge of attaining a 4% income now, compared to when the fund launched in 2012, adding that he would not be able go too much beyond 3% in this environment without taking increased risk - something he understandably does not want to do. His fund has been one of the best performers over five years in the Investment Association Global Equity Income sector, returning 73.1%.

And he is not the only one facing that challenge. Many equity income managers have had to make the same call, as the challenges of slowing global growth and geopolitical concerns run rife.

One of the dilemmas we have had as a multi-asset team in the past 12-24 months is that the chase for income assets has led to anything offering a quality yield becoming increasingly expensive. Even within our own funds, where we are buying specialist investment trusts, you can see the demand for those products in the wealth management and private retail space has gone through the roof.

For example, in the investment trust space, quality income products are trading at ridiculous premiums of 20% or more. These are trusts known for being dull and boring, such as infrastructure or mixed renewable energy. The latter is a case of simply putting a solar panel on the floor - once this is installed it is minimum maintenance and pays you a yield. For me it makes no sense: you should be selling - not buying - these products at a 20% premium.

On a broader scale we could have sold lots of investments, but the challenge is where to re-invest the capital. Holding more cash simply becomes a drag on performance.

We have been topping up specialist bond funds and strategic bonds - not for excessive yields, but for the additional care on capital. We are also looking at areas like Japan where we are finding pockets of value in the region. Investors may want to consider the Baillie Gifford Japanese Income Growth fund, which aims to benefit from the improving corporate governance in Japan, as more and more businesses move towards a progressive dividend-paying policy.

Those wanting more of a regional stance might consider the Jupiter Asian Income fund, which typically has a higher developed market exposure, notably in Australia, making it a relatively defensive Asia Pacific option.

Those preferring to go down the bond route might like the TwentyFour Dynamic Bond fund. The fund is managed with an emphasis on credit risk to ensure protection of investors' capital and income wherever possible. It also has a consistent exposure to asset backed securities - a specialism of the team which allows them to stand out from their peers.

Darius McDermott is managing director at Chelsea Financial Services and FundCalibre

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