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Sustainable higher income will still be hard to find in 2019

18 December 2018

Investors seeking sustainable higher income may need to invest for the longer term and accept that their capital is at risk, says Rupert Rucker, head of Income Solutions, Schroders.

Income looks set to remain a primary focus for investors as we head into 2019. Results from the most recent Schroders Global Investor Study show that the average level of income investors are seeking from their investments has increased from 9% to 10%. This is an ambitious target.

The challenge for the foreseeable future is that traditional sources of income cannot fulfil investors’ needs. In the past, investors could earn decent levels of income with limited risk to their capital by depositing their savings in banks and government bonds.

That has changed since the financial crisis, and returns on lower risk assets such as cash and some western government bonds are much lower than they were before 2008. This has resulted in a mismatch between investors’ expectations and the reality of the current investment landscape.

It is true interest rates are rising or may at least have bottomed across many developed economies. However, we have made a long-term broad assumption for our income solutions that interest rates globally will not revert to pre-crisis peaks. We foresee they will settle at levels which will still make bank deposits and government bonds an unattractive source for income for some investors.

This is not without historical precedent. Indeed, the anomaly is the spike in interest rates in the 1970s. This chain of thought is based on persistent structural disinflation from new technology, globalisation and demographics, on top of the huge debt piles that persist in many economies.

As a result, investors may find that traditional income providers offer a risk profile that meets their needs in terms of keeping their money safe but cannot in return give them the meaningful income which they are seeking, even if they lock their money up for a long time. If they adjust for inflation, their return could be next to zero or even negative in some cases.

For example, in the UK there has been a lot of noise about Goldman Sachs launching their retail bank called Marcus, offering a deposit rate of 1.5% to lucky depositors. We need to remember that inflation is currently 2.4% in the UK. It is rare to find so much excitement over an opportunity to, in effect, ‘lose money’ as inflation will still erode the real terms value of their savings.

Cash and other assets such as government bonds are therefore not the answer for some income investors, in our view. Yet the same Global Investor Study referred to above revealed that investors are still holding 20% of their assets in cash.

What are the alternatives?

For investors looking for higher income, the investment journey has become a lot more complicated. They now need to look for other investment sources to meet the income they seek. There are many investment options for them to research and understand. This is stressful.

They now have to make a choice between handing over their money to investment experts or trying to invest themselves. In both cases, the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. In addition, there is suddenly a huge choice of investment opportunities offering much higher potential returns but these come with (in general) much higher risk. And how do they know which ones will suit their needs?

They could reasonably decide to invest themselves. This is entirely viable but they may be restricted to a narrow list of choices and possibly lack expertise in conducting sufficient analysis.

The search for income is also a question of expectations. Investors may need to dial down their income ambitions in this world of lower interest rates and returns. For example, the dividend yield on global equities is around 2.5% (as of November 2018). Earning sustainable higher income will involve taking on more risk (particularly in terms of the volatility of day-to-day changes in the value of their capital). Investors will need to remain invested for a long period of time, as that is the only way that short-term declines in capital values can be restored and income earned.

In short, while interest rates might be on the rise in 2019, investors may need to look beyond cash savings to achieve their income goals.

Professional Paraplanner