Recent market volatility has left equity investors questioning the stability of dividend income streams
The central banks response to COVID-19 mean interest rates are likely to remain close to zero for some time
In this piece we explore a multi asset approach to harness income while managing total risk to generate a reasonable level of yield in this period of uncertainty
Since the spread of COVID-19 the world has had to adapt. That has created a lot of challenges and headwinds. The necessary measures to curtail the spread and flatten the curve have been hard on businesses. Global economies in some parts of the world have temporarily shut down as social distancing means many are unable to go to work - the manufacturing sector particularly hard hit. Governments and central banks for their part, have taken the attitude that too much is better than too little and are doing everything they can to limit the economic damage and help keep businesses afloat.
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.
While COVID-19 is having a significant impact, investors need to re-set expectations. While it will be hard to deliver comparable levels of yield from previous years, but there is still a wide range of assets that can help build a portfolio that:
Delivers a total return
The views expressed in this material are the views of Rafiq Choudhury through 10 June 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.
A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing.
Real Estate Investment Trusts (REITS) investing may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrowers.
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate, precious metals and natural resources. Investments can be significantly affected by events relating to these industries.
Investing involves risk including the risk of loss of principal.
Investing in high yield fixed income securities, otherwise known as "junk bonds", is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
The above projections are based on certain assumptions and analysis. There is no guarantee that the estimates will be achieved.
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