Big investors in Asia and Europe are increasingly focusing on receiving regular investment income, followed by the opportunity for capital appreciation – a reversal from previous years.
The growing importance of income investing was revealed by recent research carried out among Fidelity Worldwide Investment’s institutional investors. The independent survey of major institutional investors across Europe and Asia was undertaken by Greenwich Associates and revealed that most investors have experienced a fall in returns in recent years, which has led to an increased emphasis on income and a greater willingness to consider a wider range of income-paying assets.
“Low interest rates and bond yields are encouraging a search for yield that forces investors – institutional, wholesale and retail – to look towards assets with more attractive risk-reward characteristics,” said the Fidelity The Age of Income study.
It found “the search for income – already a powerful investment theme – is set to grow in importance over the next decade and beyond.”
The study revealed several asset classes that were being favoured by institutional investors over the next five years:
- investment-grade bonds (both developed and emerging markets) and high-yield bonds
- equity dividend income
- real estate strategies.
“Within traditional asset classes, there has been a shift towards investment-grade credit (developed and emerging markets), high-yield bonds and high-dividend equities. Together with real estate investment and infrastructure these are the asset classes considered to provide the most favourable trade-off between income and the risk to the underlying principal.”
Fixed income: looking beyond government bonds
There has been a 70% reduction in the pool of sovereign bonds with AAA status over the past year, the study found. It also noted the demand for assets considered safe had been significant and put downward pressure on the yields of US and German bonds – and increasing the price of safety.
The study urged investors to differentiate between government bonds and invest in fiscally sound sovereigns, such as Canada and Australia, and include the highest-quality investment grade corporate bonds of robust multi-nationals – as such companies offer better credit risk characteristics than many sovereigns and allow investors to offset sovereign concentration risk.
Equity dividend income: historically attractive yields
In the long run, if dividends are reinvested to augment the capital accumulation rate, equity income is a compelling strategy for investors who do not require cash distributions.
The study noted the extra returns from dividends can also provide a valuable margin of safety against price declines if volatility continues.
However, a high yield alone does not necessarily imply value. This was readily demonstrated in 2008 when bank earnings dropped sharply, by such a degree that dividend payments were no longer sustainable for many US and European banks. A fundamental approach focused on companies with robust financials and business franchises that allow them to sustain, or grow, their dividends is key.
Commercial real estate: driven by income returns
Commercial real estate returns are dominated by income, with around two-thirds of total return from real estate attributable to income.
The current point in the cycle provides an opportunity to access historically high yields and the prospects for long-term capital appreciation are good, noted the study.
Overall, the study said “what might have been seen previously as a move up the traditional risk spectrum can be characterised as a measured response to a changing risk landscape and a willingness to consider higher yielding assets that look more attractively valued.
“We believe the current market environment offers an opportunity to access attractive yields without necessarily taking on significantly more risk in fixed income portfolios, quality-focused equity-dividend portfolios and commercial real estate portfolios.“ In terms of risk, the study found “unsurprisingly, credit/sovereign risk in the search for higher investment income was cited most often as the key risk to the principal value of investments. Interest rate risk was next.”
The study summarised the shift in investment strategy as:
This shift in allocation is likely to alter the investment landscape as income producing investments are bid up by investors.
“At a time when traditional sources of supply are shrinking, demographic factors are increasing the demand for income. A surge in the number of retirees and increased longevity means more people in retirement for longer, needing more income to maintain their living standards.
“The global retirement population is set to surge from 800 million in 2011 to 2 billion by 2050, (according to the United Nations). Average life expectancies have increased markedly in the last 50 years. Individuals being born in developed nations now can expect to live well into their 80s on average. This is forcing a major reassessment of how much money/income pensioners need in retirement.”