December-January 2015

INVESTEC GLOBAL ADVISOR FORUM: The income upgrade

GemsInvestors are looking for alternative sources of income as traditional streams come under pressure. But obtaining returns is getting more risky.

A longer life expectancy means people are spending more time in retirement drawing down on their capital, while legislation in countries such as the UK is allowing people to access and spend their savings more quickly. Meanwhile the interminably choppy economic conditions have led a general shift towards risk-aversion and low-risk investments – particularly bonds and defensive dividend-paying equities. The yields on UK equity income funds, for example, and even bond funds, have meant a significant decline in clients’ income streams. 

Yet when a panel of advisors met to discuss the issue at Investec’s recent Global Advisor Forum, there was no shortage of insight into the alternative sources of income that are emerging. One over-riding theme was that the search for greater yield has sparked a conscious appetite among UK clients for greater risk: swapping cautious income-producing solutions like government bonds and investment-grade bonds for riskier equity income or strategic bond funds, which have higher exposure to high yield. And the products themselves are getting riskier too. Equity income funds and strategic bond funds are moving higher up the risk scale: the AAA exposure of the average strategic bond fund in the UK has collapsed over the last four years, and been replaced by BBB and even lower quality credits.

IGAF income boxThe problems in this approach are all too apparent. A high initial yield may seem attractive, but as a strategy it’s not as wise as delivering a consistent, sustainable, low volatility yield. And to attain the latter requires a significant shift in the investment process – everything from basic capital market assumptions to the way a portfolio is optimised.

OTHER STRATEGIES
Yet there are other strategies that may help those wishing to cut down their general high-yield exposure. Take upstream bond investing, which may offer some protection on the downside, instead of the riskier approach of putting everything into buying one high-yield fund. Nor is a single asset class a good idea – clients are being urged to expand their investment opportunities into other assets. Some investment banks are developing downside protection, in which the client takes income from the portfolio. They will have to go up the risk scale to get the higher income, but it comes with capital protection. Clients in different regions want different outcomes from income. In Asia, for example, there may be a willingness to take on more risk because income products are seen more as a source of high return. In South Africa, where interest rates are high, there is yet a different perspective on income.

One participant said they were considering a new model of “cradle-to-grave” portfolio construction, where the investor sits with the same portfolio for a far longer period of time, while the fund manager tailors it as a total return fund.

Yet the Global Advisor Forum also agreed on a key point: the client’s demand for income isn’t necessarily healthy in itself. At the moment, with interest rates, inflation and yields all low, if a client is anxious about income, the advisor would be wise to insist they can’t have it, rather than take them into an inappropriate asset class in order to meet their demands. A participant likened the old way the industry appeased such desires for guaranteed income to a parent caving in to a child’s demands for chocolate at 5pm – they may want it, but it doesn’t mean it’s good for them.

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