More than ever, argues Gill Hutchison, income investors and their advisers should consider relying upon good professional managers - while making sure they understand the nature of the journey they can expect
Touring the country recently with Professional Adviser's Multi Asset Roadshow, David Jane and Anthony Rayner, the co-managers of Miton's multi-asset fund range, presented their approach to income investing. This session was a reminder of the opportunities, challenges and dangers of income investing.
Investors have typically relied upon the idea that investing in income-generating assets is a lower-risk approach, as it points a portfolio naturally towards fixed income securities and dividend-paying shares of more established, larger-cap companies.
Today, that idea is challenged. Thanks to persistent, ultra-low interest rates and unconventional monetary policies, asset markets - equities, fixed income and property - have all rerated as global money flows search for a fruitful home.
The hunt-for-yield dynamic is very much alive and kicking - whatever you think about the current level of bond yields, the reality is that global investors are still desperate to plough their money into credit markets in order to achieve an additional yield premium, however slim that spread might be.
Quite rightly, therefore, Jane and Rayner highlighted it is a particularly risky time for income-seeking investors. When your starting yield on UK government bonds is in the region of 1%, an investor's total return can be eroded rapidly by a fall in price.
The question of how many investors are prepared for the reality of capital losses in the future is an unanswerable one. Income portfolios have delivered beyond most people's expectations in recent years, with fixed income markets contributing handsomely to total returns as yields have fallen. Negative outcomes may come as a big shock - particularly to less experienced investors.
These are certainly tough challenges but that does not mean the opportunity set for income investors has completely evaporated. Income investors are just having to work harder to ensure they are being suitably rewarded for the risk they are taking.
By way of example, increasingly, we are seeing fixed income fund managers turn away from new bond issues because spreads are too tight and also being particularly careful about an individual security's terms and covenants. Momentum may be in charge for now but we all know what happens when the tide goes out … managers want to be as covered as possible - and we want them to be as well!
We would argue strongly that this backdrop supports the case for outsourcing to professional income managers who have the skills and resources to take on specific and calculated risks as well as the capability to diversify across different income sources.
Apologies if you are taking a deep sigh as you hear the diversification argument rolled out again but, in a world that is relatively starved of attractive income opportunities, the wider your net, the better your chances of achieving your income objective.
Plenty of choice
The fund management sector has been pretty busy launching multi-asset income products over recent years, so there are plenty to choose from. For investors, the most important initial considerations are to ascertain what level of income you are seeking and how much capital volatility you are prepared to tolerate.
Clearly, if you want a high income, you need to accept the consequences. Veteran bond investor Paul Reed, latterly of Aberdeen Asset Management, had a loyal client base who lauded the regular and high income his high yield fund delivered, but rarely queried the elevated capital volatility.
For a less racy version of income investing, diversification clearly helps. Artemis High Income invests in a broader spectrum of bonds, as well as equities, and has had its fair share of volatility over the years - but it does its job and its well-established client base appears to understand the nature of the beast.
Some of the more recently launched multi-asset income products are more complex in nature but have the benefit of greater diversification and a broader investment palette from which to locate income ideas.
JPM Multi-Asset Income is one such fund and it invests globally, while seeking to maintain a risk profile in keeping with a 60% equity/40% bond portfolio. The fund can be materially exposed to risk assets in the pursuit of a regular and attractive income and so, again, a moderate risk appetite is of the essence.
The same can be said of M&G Episode Income, where the manager is passionate about retaining and building upon the capital base of the fund with a view to ensuring a sustainable and, where possible, rising level of income for his clients into the future. In a similar way, the manager is not shy of taking on risk where he believes value is present and, here too, investors should be prepared for some volatility in the unit price.
Some of the newer generation of funds are managed with a heavier reliance upon capital preservation. Aviva Investors Multi-Strategy Target Income and Invesco Perpetual Global Targeted Income, for example, seek to deliver specified income levels in excess of cash, as well as preserving capital.
Much like their sister target return funds, they are suited to investors of a more cautious nature who are less tolerant of drawdowns along their investment journey. The wide investment reach of both these teams and their risk management tools are crucial factors in their ability to satisfy the income and capital preservation objectives, which is not a straightforward task.
Circling back to Jane and Rayner's comments, income investing is a somewhat treacherous business these days. More than ever, we believe it makes sense to rely upon good practitioners in this field but, at the same time, it is crucial to understand the nature of the product you are buying and the journey you can expect.
Gill Hutchison is research director at The Adviser Centre. To access the firm's free-to-air fund research and consultancy service, please click here.
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