Generating real income without destroying capital
For many investors - especially those in retirement - generating real or above inflation income is acritical goal. Yet in an era of sluggish global growth, “lower for longer” interest rates and heightened volatility, it can be challenging to target an attractive level of income without incurring undue risk to capital. PIMCO believes fundamentals, technicals and valuations have aligned to make investment grade credit one of the most compelling risk-adjusted opportunities for income investors today. Here are three actions investors can take to help determine if they might benefit from an allocation to this large and diverse segment of the global bond market.
1. Review current sources of income
Australian investors often take a barbelled approach to income generation– offsetting low-risk term deposits with higher yielding investments, such as high-dividend-paying stocks and hybrid instruments. Yet many of these higher-yielding income sources can be vulnerable to significant mark-to-market volatility, or even permanent capital erosion. Investors who are uncomfortable with the amount of volatility in their income portfolio might start with a detailed review of their current sources of income - and the contribution each is making to capital risk.
2. Ackowledge the economic environment
PIMCO believes that the New Neutral, an environment of low global growth and interest rates, is here to stay. For Australian investors, this “lower for longer” environment may be even more intense than many expect. Consider that two of Australia’s largest trading partners – China and Japan – remain on an easing path, with the Bank of Japan introducing negative interest rates in January 2016. Importantly, PIMCO does expect global economic expansion, albeit at a muted pace. This environment tends to be supportive for credit markets, and credit spreads are presently wide compared to previous periods of similar GDP growth.
3. Consider income sources with capital preservation qualities
Investment grade securities tend to be meaningfully less volatile than equities. They also typically offer higher yields than term deposits, albeit with additional risk. For this reason, investment grade credit offers investors the potential to generate positive after inflation returns, without eroding capital over time. PIMCO also believes that now is a particularly attractive time to invest. Along with a supportive fundamental environment that should keep defaults low, valuations have been attractive, and technical factors remain favorable, as issuance is expected to contract amid robust investor demand.
View our latest webcast where Rob Mead, managing director, head of portfolio management Australia explores a case study on the ‘search for income’ across popular sources of income and how they have preserved capital.
Download a pdf version of this article here.
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