Latest stock market news from Wall Street -

Wednesday, June 19, 2013

Bank on six principles of income investing

The Business Times © Singapore Press Holdings Limited

THE current macroeconomic and financial market environment remains supportive of income-focused strategies, say Aymeric Forest and Iain Cunningham, fund managers of Schroder ISF global Multi-Asset Income, in an article.

There was an exodus from high-yielding securities after the US Federal Reserve talked about stimulus tapering a month ago. The Singapore real estate investment trusts (S-Reits) index plunged by some 14 per cent in the three-and-a-half weeks after.

But according to Messrs Forster and Cunningham, the deleveraging process that began in Western economies in 2008 has forced developed market central banks to provide support for economic growth. They have cut interest rates and printed money as customers and businesses reduce expenditure and repair their finances. This has led to near- zero interest rates in many developed nations and resulted in investors struggling to meet their income requirements. "Although progressing well, we believe the current deleveraging that is currently taking place still has some way to go."

In the US, aggregate debt peaked at 385 per cent of GDP in early 2009 and has since declined steadily to 355 per cent of GDP. "In the 1930s, however, debt-to-GDP ratios fell to levels considerably below where they peaked, leading us to believe that we are only part way through the current deleveraging process," they said.

Against this, where continued deleveraging is acting as a headwind to economic growth in the developed world, central banks are likely to have to maintain highly accommodative monetary policy measures to encourage growth.

This was the case in the 1930s, where interest rates were moved to near-zero in the early 1930s and remained there until the early 1940s. "The requirement for policymakers to provide this support at present should, in our view, lead to a continuation of near-zero interest rates until the current deleveraging process has further progressed," they said.

In this environment, where it remains challenging for investors to meet their income requirements, income-focused strategies should remain well supported by continued demand for higher-yielding assets.

Tread carefully

However, given that the current environment is characterised by tepid growth and plentiful liquidity, they believe that investors who are searching for income should tread carefully when exposing themselves to asset classes that are more volatile than they are used to.

Messrs Forest and Cunningham set out their principles for income investing which they hope will help guide investors through the challenges of the current environment.

The six principles are:
•One, be careful when investing in passive-income products. Investing in generic income products like exchange-traded funds (ETFs) can result in unnecessary exposure to avoidable risks. For example, income-focused equity ETFs can be highly concentrated in a small number of sectors, such as utilities, leaving investors exposed to, for example, regulatory risk. They say investors should pursue more bespoke strategies designed to minimise such risks.

•Two, pursue a diversified approach. Investing in single- asset classes for income can leave investors exposed to the specific risks inherent within those asset classes. Whether it is market risk in equities, liquidity risk in high-yield debt or the political risk inherent in emerging-market debt, these risks can lead to significant underperformance by particular asset classes. By investing across a spectrum of asset classes, investors can diversify these risks and produce superior risk-adjusted returns.

•Three, focus on higher-quality assets with sustainable income. One of the biggest risks in investing is the risk of permanent capital loss. Investing in higher-yielding securities without paying attention to the security issuer's future ability to pay dividends or meet coupon and principal payments risks permanent capital loss. It is imperative to focus on investing in high-quality securities that are able to sustain and, for equities, to grow their income streams in order to minimise the risk of capital loss.

•Four, take advantage of opportunities globally. Investors who are geographically restricted (for example, by focusing too narrowly on their home market) have a reduced opportunity set compared to those who invest globally. Assets in certain regions can be expensive at points in time, while assets in other regions can simultaneously be cheap. By investing globally, investors can take advantage of opportunities in different regions whenever they present themselves.

•Five, be flexible and unconstrained. Different asset classes offer value relative to other asset classes at different points in the economic cycle. A flexible and unconstrained approach should be taken when managing exposure to different income sources. This allows investors to take advantage of relative value opportunities in different asset classes, styles and market cap size over time.

•Six, analyse risk and manage it carefully. By following the first five principles above, concentration risk and the risk specific to individual asset classes and securities should be minimised. However, it is also important to take into account liquidity risk to ensure that assets can be bought and sold with ease.

It is also important to understand the amount of risk being taken and to examine how your portfolio will perform in different market environments. An active approach to risk management, in order to understand the sources and portfolio implications of different types of risk, can assist in protecting a portfolio during turbulent markets, they said.

No comments:

Post a Comment