With rising dividends and bond yields higher, the outlook is looking brighter for income investors. We explore how income streams are picking up across asset classes – both traditional and alternative – and assess the prospects from here.
The long-term case for income investing is a strong one. It may be that a regular income is required from a client’s capital in retirement or that income is reinvested to bolster growth potential. Studies continue to show the importance of reinvested income as a driver of long-term total returns – compounding can have a powerful impact. Income orientated investing can also make sense from a risk/reward perspective too, especially for more cautiously minded investors. Why? Because income strategies typically emphasise well-managed companies capable of maintaining dividend or coupon payments to their share and bond holders even during challenging times.
Recovering from the pandemic
With the emergence of Covid-19 and resulting economic shutdowns however, many income generating investments struggled. Businesses saw cashflows significantly down which in turn impacted on their ability to pay dividends. And with shutters down on commercial premises the likes of property funds saw their incomes drop off dramatically. The good news is that with economies emerging from the pandemic we’re seeing a real pick up in income streams across all asset classes.
Equity income – on the up
2022 has been good for dividends with AJ Bell’s Dividend Dashboard commenting that it could be the FTSE100’s second best year for cash returns. Several factors lie behind the impressive performance – UK banks have been able to resume dividend payments (from February 2021) but most notable have been returns from the oil and mining sectors as they benefit from soaring commodity prices. Rio Tinto is expected to be the UK’s biggest dividend payer in 2022. Improvements in dividend cover also bode well for the resilience of income payments and many companies are expected to continue building this buffer given economic uncertainties around inflation. The improvement in dividends is a global trend with many regions showing double digit growth. In North America for example, 99% of companies increased or held their dividend steady – a new record (source: Janus Henderson Global Dividend Survey Q1 2022). Against this backdrop, our take is that we’ll continue to see mild improvement in income from equities.
Income from real assets
Yield from property has shown a similar recovery. The covid lockdowns caused significant disruption to income flows from commercial property assets but economies opening have seen rental flows pick up and income to investors resume. Our preference has always been for property exposure with less economic sensitivity. Currently for example, we have positions across a range of sectors that have done well historically in recessions should we enter one (including supermarkets, healthcare, and care homes). Many of these also offer scope for upward rent review, often via some form of inflation-linking, which gives us optimism for improving income flows into the portfolio. Our biggest property holding – Darwin Leisure Limited – resumed quarterly dividends in the second half of last year as well.
Are bonds getting interesting?
We’ve long been relatively cautious on fixed income – a stance prompted by our assessment that with historically low yields on offer there was very little value to be had. With central banks shifting into tightening mode however, there has been a significant rise in bond yields. As a result, we’re seeing opportunities selectively – the shorter-end of the bond market looks interesting but more broadly we continue to favour strategic bond funds. Our thesis being that talented managers with flexible remits are better placed to deal with risks like soaring inflation and deteriorating profit margins. Protecting capital will be a key factor in our thinking around bond fund selection, as well as looking for funds with duration management skills as interest rate expectations oscillate.
The income specialists
The last few years have underlined the importance of diversification – something we actively emphasise in our CT MM Navigator Distribution Fund. Alternative asset classes can provide us with access to income streams less exposed to the prevailing economic environment and currently, we’ve a mix of assets drawing on the likes of care homes, music royalties and infrastructure. Within our ‘income specialists’ we see scope for a stable and potentially improving income from here.
Outlook
It’s been really encouraging to see the improvement in income across asset classes – flows that have helped lift our portfolio’s yield back towards its pre-pandemic levels. Looking forward, it’s important to acknowledge that the outlook is an uncertain one. Geopolitics continue to cast a cloud and with rates rising as central bankers attempt to wrestle inflation back under control there’s a real risk that a recession is on the cards. Against this backdrop we’ll stick to proven principles – emphasising diversification across asset classes/geographies and tapping into the very best active management.
