4 min read 9 Mar 21
Despite dividend cuts and low bond yields, you can still target a healthy and rising investment income – if you cast the net wider
Since the start of the COVID-19 pandemic, the twin engines of investment income – bond yields and company dividends – have stuttered.
The economic disruption caused by coronavirus lockdowns has put many companies into difficult positions. To help preserve cash at this difficult time, shareholder dividends have often been reduced or cut altogether.
The income available from investing in bonds has fallen for a very different reason. By and large, governments and companies have kept up their repayments to bondholders in this challenging period. Instead, demand from investors and central banks – who have been buying bonds to support their economies – has pushed up the price of many bonds, pushing down the income yields they offer. Bond prices move inversely to bond yields.
All this means that generating a healthy income from your investments just got that bit harder. But it is still possible, in our view. The key is to consider casting the net a little wider for investment income and, perhaps, to be a little more adventurous, if you feel you can afford it after considering the risks.
Bonds have traditionally been a mainstay for income-seeking investors, especially those looking for a reliable source of income in retirement. While considered to have a very low risk of default, the bonds of developed market governments like the UK, US, and Germany are likely to disappoint on the income front, with their yields currently near historic lows.
This is not to say you cannot generate a healthy income from bonds, but to generate a decent income, you may need to take on more risk. Although they are usually more likely to default on their debts than governments, companies’ bonds can potentially offer higher income returns.
Within corporate bonds, there is a spectrum of issuers from which you can choose, according to your approach to risk and return. These range from the perceived quality of investment grade issuers, who are seen as unlikely to default, through to riskier high yield bonds, which tend to offer relatively high prospective income yields, but a higher chance of default. You can also look to diversify by investing in corporate bonds across different sectors and geographies.
Looking beyond developed markets provides another way to pursue higher income. The bonds of companies and governments in emerging markets are typically seen as riskier, and so have the potential to offer higher yields. But, given higher rates of default in emerging markets, being selective in your investments is crucial.
To illustrate the higher yields on offer, the chart below compares the real yields – adjusted for inflation – on 10-year bonds issued by the governments of three major emerging markets – Mexico, South Africa and Indonesia – with those of the US. (By way of a simple example, a bond with a 3% nominal yield would offer a real yield of 1% if inflation was 2%.)
Source: Thomson Reuters Datastream, 9 February 2021.
Past performance is not a guide to future performance.
Since the onset of the COVID-19 pandemic, many companies have either cut or cancelled their dividends. This, combined with the recovery in share prices since early 2020, means dividend yields – calculated as the value of annual shareholder pay-outs per share as a percentage of the current share price – have also fallen in many markets.
Soaring share prices, especially those of technology companies, have driven the dividend yield on the overall US stockmarket towards historically low levels. The dividend yield on the S&P 500 Index of the largest US companies’ shares was 1.5% at the start of 2021. This matters for income investors around the world because of the US’ dominant position in global stockmarkets.
Nonetheless, there are higher levels of dividend income to be found in some other major stockmarkets. The UK, for instance, stands out for retaining relatively high levels of income distributions, despite widespread dividend cuts in 2020. At the start of 2021, the dividend yield on the FTSE All-Share Index of UK-listed shares stood at 3.4%
Index total returns over five years (£)
Source: FTSE Russell / S&P Dow Jones Indices, 11 January 2020
Past performance is not a guide to future performance.
It is worth remembering, though, that dividend yields are always prospective and never guaranteed. Bear in mind too the importance of potential dividend growth. It is entirely possible that companies with lower pay-outs today will raise their distributions if they successfully grow. Conversely, struggling companies with chunky dividends will inevitably have to reduce them at some point.
Another way of targeting a higher income from your investments is through active multi-asset strategies that can invest in a range of assets from around the world.
By taking a tactical approach to asset allocation, whereby an investment portfolio is dynamically adjusted, active multi-asset fund managers can look to pounce on opportunities to buy prospective income streams at a good price. They can aim to do this whilst also managing investment risk, financial and non-financial, seeking to provide investors in their fund with a regular investment income.
At a time when it has become harder to generate income streams from traditional sources, the flexibility of a tactical approach to asset allocation could help meet your investment income goals.
The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.
The value of a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. Past performance is not a guide to future performance.