Income investing in trying times
7 April 2020
How can fund managers negotiate the current environment when seeking income? David Jane, fund manager, Premier Miton Investors considers strategies from a multi-asset perspective
The current market downturn has created an especially challenging environment for income managers. All the major stalwarts used by income generating funds have been negatively affected, either by market movements or regulatory intervention.
Recent events have created something of a perfect storm for income mangers. Equity income has suffered from the cancelation of dividends, fixed income managers have suffered from significant capital losses amongst higher yielding bonds, in both corporate and emerging market space, and many specialist income vehicles have suffered falls as a consequence of moving to significant discounts to net assets as a result of investor selling.
Equity dividends have, in recent years, been a major source of income for multi-asset funds. The recent bull market focussed on technology and quality growth, rather than value and high yield. Despite steadily falling bond yields and interest rates, many unfashionable companies remained on high yields and some even fell to ever higher yields. These stocks, often in the oil, resources and financial sectors proved a good source of income for yield seeking investors.
However, the current bear market has taken a heavy toll on these areas. Oil has been very hard hit by the current price war. Mining has been heavily impacted by the decline in economic activity worldwide, particularly in China. Financials, having initially been weak as a result of expected bad debt increases are now further impacted by regulatory insistence on dividend cuts.
In some cases, even previously declared dividends are now not going to be paid. Only in times of massive distress have dividends that have actually gone ‘ex’ failed to be paid. Even safe industries such as utilities have been impacted in Europe. Here, declared dividends have been missed due to the inability to hold an AGM to approve the dividend. These are unprecedented times for equity income investors.
In fixed income the challenge has been similar. Higher yielding areas in fixed income have been hard hit in the sell off, particularly financials and energy, just like equity. At the same time the big falls in government bond yields mean that, despite much more attractive spreads, investment grade yields are not especially high. The falls are a double edged sword for high yield investors. Owners of these bonds will have lost money but discerning buyers can now buy at much higher yields. This is of course very much dependent on how bad the current recession is likely to be: many areas in high yield will see defaults as a consequence of the downturn.
Elsewhere, investors have been selling indiscriminately in the specialist fund space. This area suffers from a two-fold problem. An investor base which is prone to sell in troubled times and high levels of illiquidity. For this reason, even good quality income strategies in this space have fallen to heavy discounts to underlying asset value. Weaker funds have been especially hard hit. Many of these discounts are sure to be reversed as markets begin to normalise.
Dealing with the challenges
As multi-asset managers, we have the advantage of not being tied to a particular asset class to generate our income and have a focus on both capital and income returns. However, even with that flexibility these are very challenging times. Obviously, it is possible to build a healthy income stream for the future given the much-reduced prices, especially as we had high cash and government bond weightings prior to the sell off.
Current income, however, is particularly challenging for investors. A substantial proportion of the market’s annual equity income comes in the second quarter in the form of UK and European equity dividends and this is vanishing before investors’ eyes, even from areas you might think as relatively safe.
In our view the most sensible strategy is to focus on the longer-term income and capital profile of the funds rather than getting caught up in a short-term perfect storm for income.
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