Multi-asset
The timeless nature of income investing
10 min read 16 Oct 24
Capital gains took a precedence during the post-Global Financial Crisis era of ultra-low interest rates and quantitative easing measures implemented by central banks. Now we find ourselves in a very different environment, we believe income investing could be making a comeback. Alex Rolandi speaks with the investment teams to find out why this is important, and how investors can address the income challenge without sacrificing growth.
The investment landscape has changed significantly since the Global Financial Crisis (GFC). At the time, the crash instigated the most severe economic meltdown since the Great Depression of the 1930s1, ushering in a period of financial regulatory reform, quantitative easing measures, and ultra-low interest rates. In the aftermath, investors were forced to seek yield beyond the traditional areas of bonds and cash savings accounts.
This gave rise to the saying ‘There is No Alternative’ – or TINA – the notion that with rates at rock bottom, investors who wanted to achieve a decent return felt obliged to invest in stocks. Capital gains took a precedence.
The once popular and well-established strategy of equity income, in particular, was somewhat overshadowed by the outperformance of growth stocks largely led by US technology equities – companies that, until recently, generally didn’t pay dividends. Investors became accustomed to the significant and relatively rapid returns from these tech stocks and forgot about the slow and steady nature of income.
Then along came COVID in 20202, and most of the world was brought to a standstill by government-enforced lockdowns to stem the spread of the virus. Despite the significant slowdown in economic activity across the globe, growth in certain areas of the technology sector, at least, seemed to be galvanised.
“During COVID, we had this last surge of growth. This was not from the big mega-cap tech names, but actually from what we would describe as the much more speculative areas of technology, which didn’t have any cash flows, and were very much dependent on longer-term growth,” notes Stuart Rhodes, Global Dividend Fund Manager.
From a dividends perspective, 2020 and 2021 were challenging years. Equity income found itself in the wilderness once more as investors sought performance elsewhere. But this changed abruptly in January 2022. Now the prospect of compounding dividends could once again be an attractive artform.
“Rates and yields started to move aggressively upwards, putting a dent in pretty much the majority of the equity market’s growth spectrum,” explains Rhodes.
“It especially dented the speculative side, and that bubble really burst. That made a lot of people think again about being a bit more diversified than they potentially were at that stage of the cycle.”
With dividends accounting for the majority of total equity returns over the last three decades3, investors may harness the power of compounding to potentially accelerate their wealth accumulation. Indeed, Albert Einstein himself is said to have called compounding the ‘eighth wonder of the world’.
A transformed landscape for income investing
These days, we find ourselves in a whole new paradigm. In developed countries, interest rates have risen to levels not seen in around 20 years. In this brave new world, the landscape for income is completely transformed. The polarised nature of the market presents attractive opportunities, in our view.
“Inflation now appears to be moderating, but that only means prices are appreciating at a slower rate than before,” notes Stefano Amato, Multi Asset Fund Manager. “Prices are still generally higher than they were two or three years ago.”
Most end clients with investable assets are either at, or approaching, retirement age. But wealth is generally distributed unevenly between individuals. In Great Britain, data from the 2021 census shows that the wealthiest 10% held around half of all wealth, primarily in private pensions and property4. The report highlighted age as the best predictor of individual wealth: the 60-64 age group had nine times the level of investable assets than those born thirty or so years later.
“People who have had time to accumulate wealth, and therefore have capital to invest are usually in the decumulation phase of life, either still working or looking at retirement, when the need for income is more present,” says Amato.
The UK’s population is expected to surpass 70 million by mid-2031, while life expectancy is also projected to increase for both men and women, rising to 92.5 and 94.6 years respectively by 20705. Over the next half-century, the pension age population will likely continue to grow, putting further pressure on the old-age dependency ratio.
“For people not in a phase of their careers where they are earning well or commanding more salary bargaining power, they really feel the impact of rising prices. Having a portion of their investments that specifically targets not just income today, but also growing that income over time, is quite important for them,” explains Amato.
Investors looking to generate a regular, long-term income by taking cash from their savings are often faced with the decision of how to choose between guaranteed but potentially low-returning annuities and potentially higher-returning but riskier assets. Individuals have to make sure that the investment decisions they take generate sufficient income to keep pace with inflation without depleting their pot too soon.
‘We find ourselves in a whole new paradigm – the landscape for income investing is completely transformed.’
Building robust income generation portfolios
From a multi asset perspective, it is best to diversify sources of returns and income generation across a broad range of asset classes.
“This can allow us to build robust portfolios that may benefit from medium-term asset appreciation but are also able to withstand unforeseen economic shocks,” says Amato.
We believe dividend growth can be a winning strategy due to the benefits of compounding, while the current environment is also conducive to finding optimal value in fixed income.
Valuation and behavioural analysis play a key role in identifying possible opportunities across markets and geographies. Looking at the fundamentals helps situate where we are in the playing field. “You need to be dynamic to respond to changes in markets,” Amato points out.
By implementing a robust cross-asset valuation framework, diligent asset managers may identify ‘fair value’ for a wide range of assets across the world, in light of historical expected returns, economic theories, and investor preferences for each asset class.
“We look for long opportunities in markets that we believe are cheap and exhibiting signs of emotional selling such as investor capitulation, forced selling, or deleveraging,” explains Amato. “We also limit or avoid exposure to assets that we think are expensive and where sentiment is extended or complacent to growing risks.”
The polarised nature of the market means attractive prospects may be found across a wide range of sectors such as utilities, healthcare, and consumer staples in both developed and emerging economies. Taking a flexible approach, whereby the exposure to different asset classes is adjusted according to their relative attractiveness, can be a determining factor in a saturated market.
By investing in a well-diversified blend of assets expected to deliver a sufficient level of income, such as dividend-paying shares, interest-bearing fixed income instruments and property, it may be possible to grow both income and capital without sacrificing one’s capital.
According to Amato, long-dated government bonds are attractive at present, with the potential for interesting yields along with portfolio insurance properties.
Even so, there is a need to be wary of the risk of complacency. “The equities rally was very narrow. A lot of the appreciation came from a small number of companies – Big Tech and AI – which have a very large weight in indices,” reflects Amato. “But now the narrative is changing. Now there are credible objections: this is the tech, but where is the killer app? How are we going to make money?”
There is also the possibility that inflation may prove more stubborn than markets expect, in which case there would be a need for repricing. Broadening the search for income, focusing on the most attractive total return opportunities and then optimising exposures across different sources of income provides the stability needed to stand the test of time.
Diminishing inflationary pressures
Throughout the 20 years prior to the pandemic, the US Federal Reserve and other central banks had generally succeeded in maintaining a stable level of money supply growth. The outbreak of COVID led to a notable slowdown in economic activity across the world as vast swathes of the population were confined to their homes – meaning people built up substantial savings.
In the UK, for example, households saved 11% of their income throughout the first quarter of 2024, an increase from 5.8% in the final quarter of 2019, according to the Office of National Statistics. At the start of the pandemic, however, the savings ratio spiked at 27.4% as usual consumption levels dropped off6.
The aggressive quantitative easing measures implemented since COVID led to a further boost in money supply, which contributed to subsequent inflationary pressures.
This situation then reversed as central banks raised interest rates and reduced liquidity through quantitative tightening operations. Lower liquidity means inflationary pressures are diminishing and, in our opinion, will likely continue to do so, particularly as monetary policy remains tight on a historical basis.
The current unique rates-inflation dynamic has allowed for the re-emergence of the opportunity to deploy cash and increase duration in investment portfolios.
“Bonds today offer an attractive risk-reward. Not long ago, rates were close to zero, leaving investors with very limited upside compared to a large downside risk. Today, it is the other way around, particularly as we now know central banks are at the end of their hiking cycle and will likely cut rates going forward,” highlights Carlo Putti, Investment Director, Fixed Income.
When investing in the fixed income market, there are essentially two main risks an investor can take: one is the duration risk, which is the sensitivity to changes in interest rates, and the other one is the credit risk.
“What we aim to do is look for what the optimal exposure to those two risks is,” Putti explains. This can sometimes mean going against the status quo of what the market may be saying at any given time, but this can be a positive differentiator.
“After the GFC we were able to capture the risk premium in credit. But now we are in a different position,” he says. “When you look at spreads, investors are generally suggesting that everything is fine and we are still in a strong economy, but when you look at the macroenvironment, when you look at the data – such as the housing and labour markets – things are deteriorating.”
Weighing up risk
It could be a good time to take on more duration risk, while being more selective on credit, according to Putti, especially in light of the volatility in August 2024 when financial markets experienced a sharp correction triggered by a weaker than expected labour report.
“A cautious allocation to risky assets, along with a high exposure to duration, can help investors remain buoyant through the current environment,” he remarks.
With further volatility possible on the horizon, we believe complex market conditions require alternative investment routes. Remaining agile could prove critical in capturing any potential dislocations that may arise.
As we find ourselves in a stage of global transition, megatrends are forging a path to a potentially better future, albeit amidst a complicated macroeconomic and geopolitical backdrop. Nevertheless, a combination of ‘patient opportunism’ and diversification could be the necessary ingredients to help investors achieve their goals in a changing world.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.
1 Encyclopedia Britannica, ‘5 of the World’s Most Devastating Financial Crises’, (britannica.com), September 2023.
2 BBC, ‘Coronavirus: How the pandemic has changed the world economy’, (bbc.com), January 2021.
3 Bloomberg, July 2024.
4 ONS, ‘Distribution of individual total wealth by characteristic in Great Britain: April 2018 to March 2020’, (ons.gov.uk), January 2022.
5 Department for Work and Pensions, ‘State Pension age Review 2023’, (gov.uk), March 2023.
6 ONS, ‘Households’ finances and saving, UK: 2020 to 2024’, (ons.gov.uk), July 2024.
