By Chris Hiorns, Head of Multi Asset Strategies & European Equities at EdenTree.
The last decade has seen a major shift away from traditional income investing across the industry. In the retail market, savers have shifted from funds which generate income by investing in high yielding equities and bonds towards strategies which follow a total return approach.
Charities have also increasingly moved away from the ‘old fashioned approach’ of having separate capital and income accounts in their investment portfolios, where spending can only be financed from income whilst capital is preserved to ensure the longer-term future of the charity. It was argued that a total return approach was more rational, allowing investors to focus on maximising returns rather than just chasing income.
It is no coincidence that this change of approach has accelerated over the last decade – as bond yields fell to record lows and traditional sources of income from equity markets also saw yields fall sharply (such as bond proxy ‘quality’ areas of the market like consumer staples). Besides, the long bull market, and bubble in ‘growth’ stocks, seemed to show that the best investment returns could be found in highly rated tech stocks or ESG super stars with little or no earnings and even less in terms of income.
Thus, in order to generate high returns whilst providing a good level of income, a new total return approach with income manufactured from capital gains seemed to many to be the only real viable course.
The extent to which this ‘total return’ approach to income investing will survive the current re-alignment of the market remains to be seen. The idea of generating income through using a portion of the capital gains on the portfolio may have seemed sensible in the long ‘growth’ bull market but will surely appear highly dangerous in a market in which capital gains have moved to large losses.
Using further capital to generate income will clearly just serve to further reduce the capital sum. In the meantime, there are still plenty of opportunities to find high yielding responsible and sustainable investments in equity sectors like banking, insurance, telecommunications, media and industrials, as well as more niche areas of the equity market such as green energy funds, infrastructure funds and property REITs. Moreover, as central banks pull back on quantitative easing, bond yields may once again reach levels to attract income hungry investors.