As interest rates across the developed markets remain at record lows, with little sign of shifting, at least in the short term, income remains a key focus for many investors.
With pension changes scheduled in the UK for April 2015 likely to further boost this demand, a key question is where to source the extra yield from and whether the traditional asset classes or equities and bonds have had their day.
On the surface it seems a binary approach of either equities or bonds as a way to source income is no longer applicable, with many turning to multi-asset or multi-manager strategies as a way to diversify both their risk and the income opportunities.
As Rob Burdett, co-head of multi-manager at F&C Investments, points out: “The go-to income sectors no longer offer the yield they once did, and investors need to look further afield, letting go of the bias towards the traditional sectors.
“Since 2010, the change in yield of the IMA UK Equity Income sector is negative 8 per cent and the IMA Sterling Corporate Bond sector is not fairing any better, down by 22 per cent.”
But is this really the end of equities and bonds as an income source?
Ascending the risk curve
Sheldon MacDonald, senior investment manager at Architas, explains the theme for 2014 has been “lower for longer, in terms of both interest rates and inflation”. He notes that as the economic picture has become more challenging and Europe edged towards deflation there has been renewed support for fixed income assets in the second half of the year.
However, he adds: “Artificially low interest rates – financial repression - means savers and investors have been pushed further along the risk curve in the search for yield, into high yield debt and equity income.
“When investors began to perceive a return to a more normal rates environment in 2013 and early 2014 this trade unravelled to some extent, but the return of ‘lower for longer’ sentiment has again created an upswell in demand for these asset classes.
“Within fixed income the least risky assets, government bonds, yield less than the more risky corporate debt sectors. Investment grade corporate bonds offer slightly higher yields than sovereign debt but credit spreads are low by historical standards and don’t offer much scope for further tightening.
“For investors to earn decent returns from the highest grade corporate bonds would require a fall in benchmark government bond yields, but if this is your view then investing in longer-duration sovereign debt would capture this gain far more efficiently than corporate debt which by its nature is shorter-term – and thus less sensitive to interest rate moves.”
Fixed income
Christine Johnson, head of fixed income at Old Mutual Global Investors, highlights the positives of the bond sector, even in the current challenging environment.
“One of the more attractive but frequently overlooked aspects of bonds is the predictable and inviolable nature of their cashflows. Unlike dividends - cashflows are non-discretionary. Everything, dividends, capital spending, pay rises, expansion, is second in line to paying coupons on debt.
