Income investors are facing mixed fortunes and uncertain futures. Stock market gains in the past six months have helped, especially those using a total return approach, as it means they have more capital to play with. But the political uncertainty unleashed by the Brexit vote, Donald Trump’s presidency in the US and potential populist votes in Europe have made it difficult to predict trends in 2017.
UK dividend payouts have grown a healthy 1.6%, to £24.9 billion in the third quarter of 2016, according to Capita Asset Services Dividend Monitor. This is thanks to sterling’s fall after the Brexit vote.
However, dividend yield has fallen as a result of the strong market gains. The average yield on the FTSE 100 is now around 3.7%, compared with a recent high of more than 4.9% in February last year.
We asked four financial planners – all of whom featured as Income+ cover stars – how they were positioning their income portfolios in this uncertain climate.
Hunter Aitkenhead & Walker
For the past six months, the fall in yields has led Leicestershire-based Hunter Aitkenhead & Walker to manage its clients’ expectations about income, according to director Alasdair Walker.
‘Previously, we said 4% was a reasonable expectation of sustainable income,’ he said. ‘That is now closer to 3.5%, reflecting the gradual reduction in average yield of the FTSE 100. As well as the increase in valuations, we think this is due to reduced pressure on UK companies to provide yield because it is so low in other asset classes such as cash and gilts.’
Walker said that, based on a total return approach, good investment performance over the past two years had offset this yield reduction. But, given heightened political and economic uncertainty and his prediction of stodgy growth over the next four years, this cushion may no longer be available.
The firm has responded by looking beyond the FTSE to a more multi-cap approach. Though this adds volatility it also adds a crucial level of diversity, said Walker. He said another response to lower yields had been to focus more on investment costs, by moving towards tracker funds.
‘For example, Invesco Perpetual Income has a yield of 3.1%, but Vanguard FTSE UK All Share Index tracker yields 3.5%,’ he said. ‘We have been switching into Vanguard and have reduced costs by around 0.8% or 0.9% without giving up any yield. In a low-growth environment, this can mean a lot.’
Just before and immediately after the Brexit vote, Hunter Aitkenhead & Walker sold most of its large commercial property holdings, before the funds were suspended. It also bought into government bonds or strategic bonds in income portfolios.
Walker said the only response to current uncertainty was to take a neutral stance and ensure your portfolio was as diversified as possible. ‘We don’t know what events in the UK, US and Europe will mean for investments,’ he said. ‘We were using commercial property as a bond proxy, but now we have moved back to a more mainstream approach.’
He said he had observed a general move among other planners towards a total return model for income, rather than just seeking yield. ‘There have been attempts to get yield above the market, but we have seen advisers and wealth managers burnt by going into emerging market instruments, for example, looking for yield,’ he said.
Financial Planning Wales
Andrew Chorley, managing director of Cardiff-based Financial Planning Wales, said the firm had not changed its core income strategy, which performed well in 2016 and is dominated by index-linked gilts. However, it did make minor changes to asset allocation over 2016 by adding funds where it saw value.
Trio of tweaks
The first main addition was the Architas Diversified Real Assets fund. ‘It is becoming harder to diversify as major asset classes are becoming increasingly correlated,’ said Chorley. ‘But this fund achieves diversification, with a yield of over 3%, and has a wide range of holdings including infrastructure.’
Another new fund has been HgCapital Trust. ‘We like the theme of private equity via an investment trust and, early in 2016, the trust was trading at an above-average discount,’ he said.
The third addition was the CF Morant Nippon Yield fund. ‘Japanese shares continue to benefit from quantitative easing, which, coupled with a changing corporate culture, is resulting in higher dividends,’ said Chorley. ‘This is one of the few funds in the sector that offers a consistent yield.’
Chetwood Wealth Management
Richard Hansell, investment and compliance director at Somerset-based Chetwood Wealth Management, said it had become harder to take an investment position before such binary events as the EU referendum and US election.
‘Even if you had predicted the result correctly, the market reaction would probably have caught you out,’ he said. ‘Consequently, we have become less tactical in our income portfolios. We have concentrated on outstanding fund managers with consistently strong performance, rather than trying to second guess markets. We have reduced the number of funds in each portfolio, as we concentrate on our best ideas, rather than overdiversifying, which can reduce portfolio alpha.’
After the Brexit vote, Chetwood removed physical UK commercial property because some of the platforms it uses found it difficult to provide a model portfolio service containing suspended funds.
‘This is disappointing as many of the reasons we like the asset class – attractive yield and diversification away from rising yields and capital loss in fixed income – are starting to play out,’ he said. ‘We have reduced our duration in fixed income funds to cushion the portfolio against rising interest rates. But this reduces yield as lower duration funds pay lower income.
‘To combat this, we have also invested more with the Royal London Short Duration Global High Yield Bond fund, which offers a globally diverse fixed income position with low duration but a yield of 5.2% (in the M class). Its volatility is also below that of other high-yield peers.’
Chetwood has repositioned portfolios with a slight value tilt as the market moves away from highly priced, quality growth companies. In income portfolios, it holds the Jupiter North American Income fund and the Schroder European Alpha Income fund, which both have value tilts and have performed well recently.
‘We will wait and see before making any more decisions,’ said Hansell. ‘There is much to consider with Trump’s inauguration, eurozone elections, and the UK initiating Article 50.’
Equilibrium Asset Management
Cheshire-based Equilibrium Asset Management takes a total return approach to income and generally targets 5% above inflation.
Andrew Hirst, partner and chartered financial planner, said it had traditionally favoured bonds for generating income. However rising interest rates in the US and, potentially, elsewhere have led to increased yields and capital losses.
‘We think this will continue, so we remain underweight bonds,’ said Hirst. ‘Instead, using the total return approach, we can generate “yield” from structured products and absolute return strategies.’
On the day after the EU referendum, Equilibrium sold all commercial property and increased cash reserves. This increased its defensive and liquid position to protect against, and perhaps benefit from, expected volatility in 2017.
Following the fall in property fund values since then, it bought back 3% of portfolios into Kames Property Income, which subsequently returned around 10%. Hirst said: ‘We selected this fund for its high yield and minimal London exposure, as Brexit could affect this area badly.’
Also, given post-referendum inflationary pressures, Equilibrium invested in the Legal & General All Stocks Index Linked Gilt Index Trust, which subsequently performed well. It continues to avoid conventional gilt funds.
Hirst said: ‘We plan to invest more of our cash in equities in stages, starting if the market falls 5% below recent highs. We would also sell again if markets improved by 5% after that.
‘The total return approach allows more diversification, which will be paramount in the next 12 months. It also avoids concentration in high yielding bonds and bond proxy equities.’