Investing for income has been a long running theme in today’s stubbornly low interest rate environment, but the pickings are becoming increasingly slim. New found favourites such as emerging market debt and high yield bonds are losing their lustre while equities albeit the recent rally, still make investors jittery. As a result, institutions are looking for greener pastures
“Now there is a better understanding of how yield can be generated across asset classes and asset managers have become sharper in developing new solutions to meet this demand.”
Steven Edgley
Not surprisingly, as George Emmerson, investment director – UK institutional business at Standard Life Investments, points out: “There is no one-size-fits-all solution because every pension fund is different. The focus should be on their health and whether they are cash flow positive or negative. The question is how do they generate enough yield or growth to pay out their member benefits? In the past, pension funds would have a 70/30 split between equities and bonds but they found that the risk was too much. They still need equities but today the division is 50/50 or even lower.”
Fixed income instruments had become a refuge in the aftermath of the financial crisis but with short-term rates now near zero and longer-term rates still at historical lows, it is highly unlikely they will plumb new depths. When they do start to creep up, then bond holders may get caught with not only slim yields, but also losses on their principal. Emerging market debt and other popular higher yielding investments are not expected to offer much comfort as seen by the latest figures from JP Morgan Emerging Markets Bond Index Global which shows a 2/3% drop in the first quarter.
Instead of rushing headlong back into equities, institutions especially smaller to medium sized schemes are taking a leaf from their retail counterparts and moving into multi-asset diversified income funds. They not only focus on collecting income from dividends and bond coupons but also from switching between different assets. Traditionally, pension funds adopted a more silo approach to income investing and put asset classes in different buckets, but “now they are looking for everything under one banner which is one reason why we are seeing much greater interest in what we call multi-diversification income or MADI funds,” says Peter Martin, senior research consultant at JLT Investment Management.
“The other benefit is that they potentially offer a wide range of investments including property, different types of bonds, infrastructure and certain types of equity. It is not unreasonable to expect that this approach can generate income of 4% to 5% without taking extreme risk. The difference is that fund managers have to be more nimble and take advantage of opportunities when they arise”, he adds.
“In the past 12 months, interest from institutional investors has exploded mainly because bonds and cash funds cannot deliver the returns they need,” says Stephen Thornber, fund manager at Threadneedle, which was one of the first to launch a global equity income fund six years ago. “They are reluctantly going to equities for an income stream but want a more diversified approach. However, it is still early days and investors are most comfortable going the equity and bond route. They are still finding their way in terms of liquidity and how to position them.”
Meeting demand
Those fund managers who have carved out a position in the retail space are benefiting from increased interest from their institutional clients. Steven Edgley, head of institutional product and investment directors, investment solutions group at Fidelity, which launched its UK domiciled Multi-Asset Income product in 2007, says: “Institutions are shifting from looking for income as an investment style to looking for strategies with income as an investment outcome with attractive and stable distributions. The asset classes used in these funds are well established but what is new is the way they are being brought together within these strategies. Historically pension funds would seek income from a single asset class but now there is a better understanding of how yield can be generated across asset classes and asset managers have become sharper in developing new solutions to meet this demand.”
Fidelity recently added a global multi-asset income fund to its stable. Debuted in Hong Kong, the plan is to launch in Europe in the near future. The fund which invests in a diversified portfolio of global fixed income, global equities, and opportunistic assets, including listed infrastructure, loans and real estate investment trusts, targets yield at 5% to 5.5% while the UK funds are in the 4% to 6% range.
According to Edgley the fund is divided into three broad asset groups – income generating which includes investment grade bonds; income and growth which has emerging market debt and high yield; and growth assets such as equity dividend income strategies and loans.
Another variation on the theme is Schroders’ global multi-asset income fund which hit the market last year. It differs from others in that it takes an unconstrained approach which means it does not replicate benchmarks, according to Aymeric Forest, multi-asset fund manager at Schroders. “The chase for yield has pushed people into investments such as high yield and emerging market debt that do not always correspond to their investment profiles. In other words, they climb the risk ladder when they don’t have to.”
The fund which aims to distribute 5% per annum in equal quarterly or monthly payments and has a total annual return goal of 7%, invests across the equities and fixed income spectrum. “We have 25,000 securities and our focus is on liquidity as well as yield,” says Forest. “For example, everyone piled into secured loans last year and the liquidity premium is not attractive so we are avoiding them. Also we may be negative on emerging market debt because it is seen as expensive and growth is slowing, but we are looking for emerging market companies that are growing their dividends.”
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