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Where we’re finding income

4 May 2017

Richard Philbin, chief investment officer at Wellian Investment Solutions, continues his series of investment articles. This piece focusses on the key issue of finding sustainable sources of income for clients.

With the price of equities continuing to rise and bond yields remaining at historic low levels, coupled with the uncertain global outlook and the “risk free rate” being smashed by the collapse of interest rates since the financial crisis, for anyone investing for income the current investment environment remains challenging as income remains hard to find if you are focussed on any single asset class.

The price of equities has risen to high levels in key developed markets such as the UK and US, while dividend yields remain at relatively low levels globally. Meanwhile, Treasury bond yields have increased in the US on the expectation the Trump administration will boost growth and inflation, but they remain at low levels in historical terms. Yields available in other bond markets, such as UK gilts and German bunds, are significantly lower than treasuries and are near to their historical lows, while in the corporate market spreads for both investment grade and high yield bonds are also at relatively low levels.

The uncertain outlook for inflation and interest rates also makes it difficult to determine whether to invest in equities or bonds, or whether you should consider alternative assets such as property.

Given the challenging backdrop, opportunities do remain for income, but what is clear is that investors must now move away from the traditional sources of income such as government bonds and look to increase their level of risk to find them. QE has forced investors up the risk curve in search of income across every asset class.

Emerging markets, for example, look interesting both in terms of equities and debt, on a selective basis. They came under pressure last year following Trump’s presidential win, but yields appear attractive given their risk profile. They are also home to some well-run companies that generate high, sustainable and growing dividend yields. The standard of corporate governance across emerging markets also continues to improve.

Elsewhere in equity markets, stocks that pay consistent dividends on the back of transparent and predictable income streams remain attractive to investors. Bond proxies have delivered strong returns in an environment of low interest rates, but given the uncertainty of Trump’s ability to press ahead with his fiscal plans, could once again be an attractive option.

In fixed income markets, the yield from investment grade and high yield markets remains attractive to government bond yields, although the potential for further gains is limited as credit spreads continue to narrow. Areas of the short-dated bond market are offering opportunities for attractive levels of income, such as short dated global high yield which we are now running across a number of our managed portfolios.

While at a macro level we are constantly seeing changes to interest rates and inflation, the key for income seeking investors is to have access to a diversified source of income paying assets and asset classes. Due diligence as always is important; you need to know what you are buying and why – don’t just blindly take a headline yield. And maybe not taking enough risk in your portfolio could be the biggest risk of all, especially as we are now almost 10 years into this “recovery”.