It’s a troubling outlook for income-producing assets, but Tom Becket manages to pick out a few promising prospects nevertheless.
Back when life was ‘normal’ (three months ago, although it feels like three decades ago), I wrote a column for this publication about how difficult sourcing sustainable income was for investors.
Years of financial repression from central banks, far too much ‘loose money’ chasing too few assets and expensive valuations have made the income-hunting landscape for investors in most asset classes pretty barren. What investors really needed was a fall in asset values and an increase in yields to ease the negative side-effects of the zero interest rate world we faced.
Fast-forward three months, and we live in a very different world. The only factor that seems to have remained constant is that it remains extremely difficult for investors to find an attractive and sustainable income stream.
In fact, it has got even harder. Why? Let’s revisit each core asset class and reassess the income potential for the years ahead – and please allow some mental wiggle room in these unprecedented times.
We are in a financial situation where we will not be able to achieve interest on a bank account in the foreseeable future. Interest rates in the developed world will not go up for at least the next five years (arguably, they won’t go up for decades).
In addition, the ferocious fiscal fiddling by the world’s governments will mean that government bond yields will have to be suppressed by central banks, so the income from government bonds will basically be 0%; in a world where – I think – disinflation will give way to inflation, this 0% will be more like -3% in real terms.
This fiscal intervention from central banks has now been extended, and the ‘you ain’t seen nothing yet’ world that I have been expecting to arrive in the middle of the decade we have just entered has come early. The central banks of the world have given up pretending otherwise and are now buying private assets, which will probably lead to ever-lower corporate bond yields.
The best prospects that we can currently identify are in selected credit markets, where there are presently exceptional opportunities on a level with those seen in 2008. It is on such investments that we are primarily focusing our attention.
For those who want to avoid excessive risk, the Twentyfour Corporate Bond fund, which has a yield of around 3.5% from a portfolio of high-quality UK corporate bonds, is an attractive proposition. For those who want to reduce the threat of rising bond yields, the AXA Global Short Duration fund offers a yield of 2.5% but will likely have less volatility due to its short-duration focus.
Some readers would rightly counter the argument for higher-quality corporate bonds by asking why UK equities are not a better income opportunity at this time. My view is that the yields currently on offer are an illusion. I expect UK FTSE dividends to be slashed by 50% as companies decide to preserve cash in these strained financial times, or are ordered to make cuts by the regulators.
Royal Dutch Shell’s cut to its dividend for the first time since the 1940s serves as the latest illustration of how times are changing. Many companies will follow suit, and we must realise that these are not temporary measures: cut dividends will not be magically restored with – hopefully – the development of a Covid-19 vaccine.
There remain great investments in the UK equity market, but the dividend pillar has been removed as a valuation support and investors would be wise to tread carefully. The two funds where we see the best prospects for sensible income management are the Royal London UK Equity Income and Artemis Income funds.
In regard to higher-risk income opportunities, I am chiefly looking at selected higher-risk credit markets where default risks have risen but are priced into current yields. Asset- or mortgage- backed securities on both sides of the Atlantic have been hit incredibly hard and offer investors both high levels of income and almost unrivalled opportunities for capital gains.
In European markets, the Twentyfour Income fund and, in the US, the Semper US Total Return fund offer yields of 8% and 14%, respectively. These reflect the risks in the global economy but provide investors with prospects not found in other markets: sustainable income at a fair price, in a world where achieving a healthy income from one’s investments remains surprisingly challenging.
Tom Becket is CIO at Punter Southall Wealth.