Income update

As regular readers of this newsletter and our Viewpoint magazine will know, we have had concerns over fixed income investments for some time now. As Iain Stealey, co-manager of JPM Strategic Bond reiterated recently: “Fixed income investors have a problem. They need bonds to counter volatility and provide income, but interest rates are going to rise, which means they are sure to be vulnerable to losses.” But what are the alternatives?

First a word on bonds. Interest rates in the US and UK really only have one way to go, so government bonds issued by these countries are looking unattractive. In Europe there are pockets of value, as interest rates could be lowered, or are at least less likely to rise.

Corporate bonds – those issued by companies – are also looking stretched and opportunities are becoming harder to find. Even high yield bonds (those that are more risky), where there was value a few months ago, are now looking expensive. This area is still the least exposed to interest rate rises, but stock selection will remain key and bond fund managers, who were overweight in this area, are now starting to cut back.

There are more opportunities opening up in emerging market bonds, which were hit heavily when the US announced they would start slowing quantitative easing. However, for most private investors, particularly those simply seeking an income, we believe this asset class is probably too far up the risk scale. Far better, perhaps to let a strategic bond fund manager dip their toe in selectively.

Dividend-paying equities have been popular amongst income investors, prepared to take on a bit more risk, for a couple of years now. The result of this popularity has been that these companies, in most developed markets, are now looking on the expensive side. That said, we believe that, with an ageing population, there is a structural change taking place around the world that means income will remain in demand for the long term. So while these stocks are not attractive on valuations, they are likely to remain popular amongst income investors.

Higher-yielding emerging market equities are the only area looking good value, but again there is considerably more risk involved in this asset class, so investors need to be fully aware of this before deciding to allocate too much money their way.

Finally, commercial property is still looking attractive both in terms of future growth and for income in our view. The London property market may well be overheating, but elsewhere in the country the story is not the same. As an asset class it has lagged since the financial crisis began, but the outlook is now looking much better.