What are the possibilities for investors in search of income?

Solving the income conundrum

06 Mar 2018

Ageing demographics, technology disruption, regulatory change, the ‘hangover’ from quantitative easing and almost a decade of rockbottom base rates. These forces have fundamentally altered the demand and supply of income assets. If you’re hunting income in 2018 and beyond, it’s highly likely that the challenges facing you will be substantial and, in some cases, complex.

Do you re-adjust your income requirements and asset allocation decisions in the face of low yields or do you stretch for a higher yield with a degree of risk? And as concerns grow that the bull markets could finally be slowing, you may also be considering the best means of adding an element of defensiveness to your portfolio. Income strategies, by their very nature, tend to be more defensive and so could also add an element of portfolio protection. Given that backdrop, what options could you explore?

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Let’s start at the point of lowest risk - cash. Global growth is improving and it seems that central banks are willing to look through inflation. But while cash may be ‘risk-free’ it offers negative real returns, so over the long-term it’s not a viable option. The next logical step is to look at fixed income investments. High-quality, short-duration bonds offer a regular cash flow, low volatility and high liquidity. Yet the disadvantages are also to consider: the level of income isn’t attractive and there's hardly any capital growth to expect. More income can be generated by exposure to credit risk, particularly in the high yield segment, which offers attractive coupon payments. This comes with the downside of lower liquidity, higher trading costs and default risk. Equities offer several attractive characteristics, such as the opportunity for capital growth and potentially higher future cash flows which may grow in-line with inflation. However, equity income can be relatively infrequent and unpredictable, and it is vulnerable to price volatility.

Diversifying can deliver

Ultimately, no single asset offers a perfect solution for the challenges that you, as an income investor, face. Different asset classes offer different characteristics which vary through the course of a market cycle. The shape of an income strategy will, ultimately, come down to your tolerances to the trade-offs that exist between absolute levels of income, capital growth, volatility, and liquidity amongst others.

As this overview has highlighted, a well-diversified portfolio which has exposure to a multitude of income generating assets across the risk-spectrum can help deliver income. A bespoke, solutions based portfolio is one way to address the issue, or alternatively, you could allocate to a multi-asset income fund, combining the asset classes and bringing together the best each class have to offer. Whichever approach you choose, we believe that more diversified income strategies and tailored income solutions will become increasingly important for a broad range of investors.

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