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Where is the Income Opportunity?
Looking at the universe of income generating assets, we can classify them into 4 broad groups, which can be blended together according to the prevailing economic and financial environment, aiming to provide the sustainable income required. The first includes the most defensive fixed income assets, such as highly rated government bonds and investment grade corporate bonds. These tend to exhibit relatively low capital volatility, little risk of default on repayments, but pay lower yields, especially when inflation is taken into account.
The second group we classify as ‘growth fixed income’ assets. This includes high yield corporate bonds, emerging market government and corporate bonds, and sub-investment grade loans. These offer more exciting yields, but have typically experienced more capital volatility.
The third group comprises higher yielding equities, which pay attractive levels of income with the prospect of capital growth. However, equities also have higher levels of capital volatility.
In the fourth group, we find less liquid alternatives to equities such as property and listed infrastructure.
A multi-asset income approach
The primary objective of the Investec Diversified Income Fund is to achieve an attractive, sustainable income from an actively managed global multi-asset portfolio. The upcoming UK pension freedoms will provide new choices and opportunities to those in or approaching retirement. We believe that a multi-asset income fund paying a sustainable natural income could be an attractive addition to a drawdown and/or annuity plan.
The Fund aims to provide investors with a yield of 4-6%pa with a volatility of less than 50% of UK equities, however, we won’t chase income at the expense of adding risk to the portfolio. On the capital side, we seek to protect and grow capital by around 1-2% per annum. We, therefore, look to manage downside risk and minimise draw-downs, seeking to take less than half the risk of global equities.
Our portfolio combines assets with different characteristics rather than just holding a range of assets with different names. For example, despite individually paying attractive yields, there are limited diversification benefits to be had by combining higher yielding equities and high yield corporate bonds, because they are both a play on the fortunes of companies and will both tend to do well or badly at similar points in the business cycle. Within this grouping we currently prefer higher yielding equities with quality income streams, many of which are household names. These companies are benefiting from the improving growth outlook, led by the recovery in the US and UK, and offer better relative value than high yield corporate bonds. Our portfolio combines these high yielding assets with more defensive assets such as highly rated government or investment grade corporate bonds, which can do well when company prospects are deteriorating.
