Vincent McEntegart, co-manager of the Aegon Asset Management Diversified Monthly Income Fund, on why multi-asset managers can ditch the bond-proxies thanks to the changes in the bond market.
The bounce back in bond income in the past two years has made owning bonds for their income-generating qualities much more desirable.
But this has had another major effect on multi-asset strategies. The knock-on effect of bond income improvements has been to free up capital from income-generating ‘bond proxy’ equities into growth-focused stocks.
Income investors have had to work hard to capture an attractive level of income ever since the financial crisis. This was exacerbated by the final reduction in rates as Central Banks loosened policy further in response to the Coronavirus pandemic.
Move forward two years and the picture is materially different. Markets have been dominated by the twin spectres of inflation and rising interest rates. There have been widespread implications across asset classes but the dramatic reset in bond prices is perhaps the most significant.
This has given multi-asset managers the choice to shift into bonds to achieve income mandates, freeing up capital from bond proxy equities, and allowing managers to focus equity allocations on growth-focused stocks from a wider set of themes and regions.
Being less reliant on equities for income offers a chance to reshape that component of the portfolio by geography, industry and theme. Low average yield from the US equity market is no longer the issue it was. Instead, its growth potential is something that can more readily be tapped.
It would have been difficult to own companies like Microsoft (developing AI and holding a 49% stake in ChatGPT) and Broadcom (a global leader in semiconductors and infrastructure software) when income was scarce since they yield less than 1% and 2% respectively.
Outside the US, McEntegart says there are market-leading growth opportunities in related industries including integrated circuits (TSMC), power for data centres (Schneider Electric) and makers of semiconductor manufacturing machines (Tokyo Electron) whose place in a multi-asset portfolio is more assured when bonds shoulder the income burden.
Growth themes in other markets are not off limits either. Some 7.4% of our portfolio (25% of equities) is now invested in eight businesses benefitting from the technology and AI theme which has been an important growth engine while other parts of the market have faltered.
Sector-wide valuations are always in mind and the current macro uncertainty still reinforces a bias towards quality but the opportunities represented here will, we believe, prove to be significant and enduring. They will change the way the world operates, and it is right to look to be invested.
The reset in bond prices has enabled managers to look to bonds for other qualities too, he argues. In particular, access to investment-grade credit helps multi-asset managers seek lower volatility.
Adding to bond allocations, particularly in IG, allows for lower volatility. When uncertainty remains significant and asset class correlations high, it is surely better to tilt towards the contractual income of bonds and their pull-to-par nature which aids total return.
Markets wax and wane with the economic cycle, as we have seen in the 10 years since the fund’s inception. Navigating that in real time is key.
The outlook is uncertain, but the bond reset of the last eighteen months has thrown up some tremendous opportunities to rethink how we deliver strong risk-adjusted total return – a very attractive income with new opportunities for growth.
The Aegon Diversified Monthly Income Fund is celebrating its 10-year anniversary on 25 February 2024.