Why is there such a disconnect between total return proponents and income investors? David Jane, fund manager, Premier Miton Macro Thematic Multi Asset Team, has a view.
It is self-evident that total return is the most critical measure of a portfolio, whether in accumulation or decumulation. This combined with the volatility of those returns will determine the success of an investment strategy over the long term, both pre- and post-retirement. Hence, the proponents of a unit encashment approach post-retirement focus on total return and ignore the income level or even the income potential of a portfolio.
Natural income proponents focus on the income level and do not try to forecast the total return. Drawing only the income, assuming this is predictable and growing over time, provides a degree of stability and never requires dipping into capital to fund expenditure.
Of course, most portfolios are insufficient to fund retirement spending from income alone. Even for those that would prefer a better lifestyle rather than leaving the entire capital to their heirs. Therefore, even natural income proponents recognise that a degree of unit encashment will be necessary.
One major critique of an income approach is the linked problems of the unpredictability of income and the unreliability of an income style in total return terms. These are in many cases quite valid. Most funds calling themselves ‘income funds’ are no longer focussed on providing a stable and growing income for their investors. This may have been the case many years ago, when income funds were widely used for this purpose. Following the rise in total return-based performance tables, combined with the superior returns of growth strategies over the decades of lower for longer, meant that to survive these funds typically dropped their focus on income as an output. While many remained focussed on income as an investment style (a subset of a value style), few focussed on their actual distributions. In some ways this was a doubly unhelpful approach as these funds would now provide an unreliable income stream and would only perform well when value as an approach was in favour. For an adviser trying to achieve their client’s income objective this is doubly unhelpful. Hence, we completely understand this criticism when applied to most funds calling themselves income funds.
What it misses is two important factors. One is that there does remain a precious few funds that do still manage their distributions. This is entirely possible, particularly in the context of a mixed asset, or at least global portfolio. If a fund is tied to a single asset class or region then little can be done if an income shock hits, such as occurred to UK equities in 2020. Having the flexibility to diversify correctly sources of income enables a manager to avoid such difficulties if they are focussed on providing that income stream.
Secondly, it is not necessary to follow an income style or value style of management to provide a high- and growing-income stream. Run pragmatically, an income fund can perform across all market environments.
These critiques are valid when applied to most of the available income strategies, mainly because of the failure of these strategies to focus on the client need, i.e. a steady and growing income. Instead, they have focussed on beating a peer group or index, maximising income for income’s sake or pursuing income as a value investment style.
What all this misses however is the real value of income to an adviser: well managed income can provide a level of stability to a client portfolio that volatile total returns cannot.
In drawdowns, if the income on the portfolio is unimpacted or suffers limited impact, a client can observe that the real value of their portfolio might be less at risk than they might otherwise think. As a result, they might be less inclined to panic and withdraw.
The major benefit to advisers is that at the point of investment the fair expectation of total returns is the income plus expected future growth and therefore provides a strong anchor on expected returns rather than an ambiguous long term return forecast.
On what are future return expectations to be based if not the future cash flows from a portfolio? Long term returns are particularly difficult to assess in an environment of highly fluctuating market levels, leading to uncertainty as to the prudent withdrawal rate.
Knowing the natural income level of the portfolio fixes a rate that can be withdrawn before capital is eroded. The market is therefore telling you the safe withdrawal rate, as markets rise the rate may fall but the income remains the same and vice versa, year by year, day by day. With a growth strategy you are having to guess this rate.
This information should not be relied upon by retail clients or investment professionals. The views provided are those of the author at the time of writing and do not constitute advice. These views are subject to change and do not necessarily reflect the views of Premier Miton Investors. The value of investments may fluctuate which will cause fund prices to fall as well as rise and investors may not get back the original amount invested.
Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
