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M&G: Income solutions for stormy markets

24 Jan 2019

Steven Andrew, fund manager, M&G Episode Income Fund

For Investment Professionals only. The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested.

It has not been an easy year for investors drawing stable and growing income from financial markets. Stock markets have stormed up and down, while bond yields have continued to rise as major economies have moved to tighten monetary policy and raise interest rates.

Income-producing assets have been particularly hard hit. It has been the reliable, income-generative bond proxy sectors of stock markets, and the historically dependable income sources of developed country government and corporate bonds that have borne the brunt of weaker sentiment in 2018. For pension schemes seeking to maximise their income, often from traditional portfolio building-blocks, the volatility has likely been painful. However, unpredictable conditions such as the present are well suited to active multi-asset investment strategies, which seek to generate an attractive income yield from a globally-diversified portfolio and have the freedom to asset allocate dynamically between markets. As UK defined benefit (DB) schemes focus ever more on generating income from their assets, flexible income solutions that seek relative value from a wide range of assets globally should be best placed to adapt to the changing environment to meet these needs.

Income investing in volatile markets

The clear benefit of multi-asset solutions for income delivery is that they are not bound to any single asset and are able to capture the best opportunities from around the world, while avoiding those areas where prospective returns are low.

A growing global universe of income-bearing assets means that multi-asset managers with an income objective have far more avenues to pursue today than in the past. This means that delivering income does not necessarily mean ‘reaching for yields’ in ever more risky assets, so long as investors are willing to look across financial markets to source assets offering attractive value.

Diversification within asset classes, as well as between them, can enable a manager to target a reliable income yield even at times when markets behave unexpectedly. For example, within equities we see attractive opportunities in US banks and technology businesses, European financial groups and Japanese companies – as well as domestically-oriented stocks in the UK, which we feel are undervalued.

Bond markets offer different properties worldwide. Long-dated US Treasuries – those with at least 10 years to maturity – in our view can offer attractive diversification properties and relatively high yields. These can be combined with higher-yielding government bonds from emerging markets for still more robust potential diversification.

Delivering income in a rising rate world

Pension schemes’ need for income is intensifying despite the uncertainty and asset price reversals we see in financial markets. The monetary policy backdrop continues to move from extremely accommodative to more neutral conditions as interest rates rise, suggesting that the ability to generate strong returns from simply buying and holding an asset class may not be replicable going forward.

A regular, stable and growing income stream from all available scheme assets can be enormously supportive in helping a scheme manage its cash-flows. Multi asset income solutions can provide flexibility in offering income and growth in the capital base.

Taking advantage of the diversification benefits that come with a wider universe and considering risk management tools such as active currency and duration management allows multi-asset solutions greater scope to deliver outcomes that could once be expected from simple baskets of assets. We believe adopting a dynamic approach can provide pension funds with attractive alternatives to achieve their investment objectives.

For more information, please visit www.mandg.co.uk/multiasset

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