Bonds income strategies harder to justify
Typical income strategies based on bonds became harder to justify as interest rates ground lower in the 2010s in the wake of the global financial crisis and income-seeking investors are effectively forced up the risk curve, toward corporate bonds, high-yield bonds, cash-generating real asset investments, and the share market.
What is more, according to experts, Angela Ashton, founder and director of managed account provider Evergreen Consultants, and Jamie Nemtsas, director at independent financial advisory firm Wattle Partners, the income aspect of share dividends – turbo-charged by Australia’s dividend imputation system – became a major attraction, with effective yields in the 6%–8% range readily available.
They said investors would need to accept that the dividends should not be considered certain until they are paid; two, dividends were paid at the company’s discretion, and could be cut at any time – even abandoned; and that they bore the capital risk of the share market.
“As interest rates have come down over the past decade, we've had to change the way that we look at income; it's become quite driven by growth assets,” Ashton said.
“Having the central part of a portfolio with respect to income production in growth assets like property or shares introduces a lot more risk, unfortunately for clients, but that's the way you need to generate income today.”
On the other hand, Nemtsas stressed that high income was generally riskier, and ‘sustainable growth’ looked less so at the moment, if investors were thinking in terms of total return.
“You might be looking at a regional building company in New South Wales that has got a strong dividend, on paper; but it’s going to be far better to hold something like Google that has got a massive audience, low cost of capital, great balance sheet, and you're sacrificing some kind of regular income for a very, very strong company,” he said.
According to him, it all came down to rebalancing as investors were looking to ‘harvest’ capital gains and putting them back into an income-producing bucket.
“Say you have 5% cash, 10% fixed-income, 30% Australian equities, 20% global equities, and 35% real assets. If you rebalance regularly, and your Australian equities has moved to 34%, you ‘harvest’ that 4%, and put it back to cash. Your capital gain is constantly being converted into your ‘core’ capital, which we like to have sitting there as effectively three years’ worth of cash needs,” he added.
Nemtsas agreed that areas such as consumer staples, healthcare stocks and infrastructure stocks – “fallen angel” sectors like travel – offered good opportunities at present.
“There are also some great opportunities in credit, particularly in the ‘distressed credit’ space,” Nemtsas said.
“We’re looking at a range of individual investments, some stocks, some ETFs, particularly where we think they’ve been oversold, to set up portfolios for the next few years.
“We’re getting the opportunity at the moment to build portfolios totally differently than we were eight weeks ago. But we’ll stick to that rebalancing strategy – sell those that go up, keep those that go sideways while yielding income. And think in terms of total return, not in terms of maximising your income return.”
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