Income is a theme, along with capital preservation and value for money that investors look for and expect as standard from their portfolio and fund managers.
Income allocation shift
At the same time, a combination of demand (the oft-cited reasons of ageing populations, individuals spending longer in retirement) and supply-side reasons (low interest rates, low bond yields) is putting a distinct squeeze on where those sources of income can be generated.
At the Portfolio Adviser Europe Expert Investor event, three quarters of wealth manager delegates said they are going to maintain their current allocation to income strategies, with 25% saying they were going to increase them.
Their current allocation is predominantly to UK equities (according to 23.8% of delegates), global equities (22.9%) and high yield bonds (20.3%).
However, the interesting thing is they are virtually all considering changing this asset allocation, with the biggest winners being equities, with Europe (according to 50% of delegates) potentially seeing the biggest gains while global (29%) and Asia Pacific ex Japan (15%) can also look forward to more positive sentiment.
Home sweet home
Whatever they said on the day, I am sure the grand total of UK-based wealth managers with UK-based clients will stick to a UK-based income strategy.
Rupert Law, for example, a senior investment director at Investec Wealth & Investment, said: “Our home market continues to provide a selection of stocks offering sustainable income, without taking on the risk of investing in overseas currencies.
“Also, by investing in UK-based companies such as Unilever or Glaxosmithkline where substantial earnings are generated from emerging markets, an investor can receive a good income without needing to invest directly overseas.”
The question of currency exposure has to be tackled by any UK-based, sterling-earning investor so is not limited to just income investors.
Tim Norris, an investment manager at London Wealth Management, gives a check-list of things to assess given their potential impact on overseas currency exposures: inflation expectations, interest rate movements, current account deficits, public debt fluctuations and political stability.
Norris says: “With income stocks present across many jurisdictions – crudely a third of FTSE world stocks yielding over 3% are currently in Asia Pacific – currency fluctuations can have a significant bearing on total return.”
Currency: risk or return?
Importantly, he puts the currency-exposure argument in context, saying: “Attempting to understand exposures is important in enhancing these returns but should not cloud the overriding initial investment principles.”
Looking ahead over the next three years, interest and inflation rates are likely to be ahead of their current levels – certainly for a UK-based sterling earner.
Irrespective of credit crunches, fast-acting fiscal disasters and slowly-improving economic conditions, investors want consistency of income. While there are plenty of investment professionals putting strategies together that eat into capital (with investor’s approval, naturally) to make regular payments, what is important today is to be able to maintain them while taking advantage of rising inflation/interest rates.
First Wealth, for instance, positions its income portfolios with a bias towards equities with shorter duration and less directional exposure to traditional bonds and government gilts as a precaution against rising rates or inflation over the medium term of three years.
Anthony Villis, a partner at the firm, explains how he will look to evolve his income diversification through three types of strategy implementation.
Future switches
“Firstly,” he says, “inflation trades – the introduction of index-linked bonds to portfolios as well as identifying UK equity and commercial property that show strong correlations to inflation levels.
“Secondly, bond strategy rotation – increase convertibles, absolute return, floating-rate notes and short- duration high-yield bond exposure, adding index-linked investment grade corporate debt.
“Finally, alternatives – add exposure to commercial loans and leasing contracts (focus on inflation-linked income sources), equity covered call strategies, as well as interest rate futures and commodities (global inflation).”
As mentioned earlier, income investing for sterling-earners will naturally have a high allocation to UK equities. The same will hold true for fixed income strategies, irrespective of the overwhelmingly negative sentiment for most bond funds right now – the clue is in the use of the word ‘income’ in their description, given they are still an attractive way to produce regular, sustainable and high-quality income.
Thankfully, there is still plenty of choice for fixed income investors.
“We,” says John MacMahon, a founding partner at Gore Brown Investment Management, “are generally cautious on taking on too much duration in the long term although we accept there is a possibility of a series of deflationary shocks over the remainder of 2013.
“We believe that the best opportunities in bond investing come at present from exploiting a broad range of fixed income strategies including credit, currencies, curve and volatility trades, rather than just focusing on one area such as investment grade corporate debt.”
“Reconciling our diverse objectives from the sector has taken us in the direction of strategic bond funds. In this category, we currently invest in M&G Optimal Income Fund and L&G Dynamic Bond Fund.
“Outside strategic bond funds, holdings include Fidelity Moneybuilder and M&G Corporate. In the high-yield sector, we hold Kames Global High Yield and Muzinich Short Duration High Yield.”
According to Aymeric Poizot, head of EMEA, fund & asset manager rating group at Fitch Ratings, there is huge momentum for income strategies, with demand from investors across the continent at such a level that he expects two-thirds of European fund managers to launch income funds this year.
If this does play out then there will be a lot of ‘me-too’ funds to choose from but hopefully we may even be able to look forward to some brand new ones as well.