Yields on traditional income assets such as term deposits and fixed income bonds had already followed lower cash rates over the last few years. And the recent actions by central banks in response to COVID-19 mean that interest rates look likely to remain close to zero for some time.
While yields on government and even many investment-grade bonds have fallen. Income focused investors have been particularly hard hit as they struggle in a low yield world. As a result many have turned to multi asset solutions to diversify their sources of yield. Often this would mean taking on more risk by including equities for dividend yield. However, in trying to stay afloat, companies have had to adopt some unfavourable but understandable measures such as cutting back on expenditure and with the impact on earnings, many are having to cut or suspend their dividends.
Although the above measures are concerning for income focused investors, on a relative basis, these strategies still offer potential benefits. Yes, equity income will be lower than 12 months ago, but equities still provide a positive yield spread when compared to cash and fixed income. Broad market indexes that are grouped on market capitalisation do not take into consideration the company’s dividend yield. Dividend focused indicies that utilise rules based rebalancing strategies by comparison can provide a level of dividend consistency. These types of strategies seek to offer attractive yields, at least on a relative basis (i.e. when compared to the market cap group equity indexes). While we are seeing dividends cut, there are sectors where the outlook isn’t as bleak allowing firms to retain their dividends. Indeed, a few companies have been expanding their dividend payouts via special dividends. Sectors such as insurance, healthcare, utilities, food & beverage, pharmaceuticals and telecommunications include many companies that have historically paid attractive and reliable dividends. Following recent rate cuts, such stocks look even more attractive, given the ‘relative yield’ compared to the very low yield from fixed income bonds.
Having the right dividend strategy is key. The graph below supports a multi asset approach to harness dividends across a range of assets. Multi asset income investing supports the management of total risk whilst generating a reasonable level of yield. However, while yield is important investors should not chase yield at any cost. Yield, total return and risk are all key metrics to consider especially when riskier asset classes are included to harness yield. Equities for instance come with more risk, so investors should not take an all or nothing approach and should also consider the forward looking outlook for specific sector. For instance REITs still offer attractive yields but faces a number of headwinds going forward that make the sectors yield and expected return less reliable. Fixed income, even with its relatively low yields still has a place to play in an income portfolio especially in helping to moderate risk.