Finding income opportunities to generate defensive returns

Market volatility has returned, tech stocks have fallen and President Trump’s Twitter feed continues to unnerve investors on a global scale. But what has this meant for bond and equity markets and where can investors find the best income opportunities?

Finding income opportunities to generate defensive returns

Market volatility has returned, tech stocks have fallen and President Trump’s Twitter feed continues to unnerve investors on a global scale. But what has this meant for bond and equity markets and where can investors find the best income opportunities?

Jason Borbora, Assistant Portfolio Manager, Investec Diversified Income Fund discusses one of the key market lessons from an unsettled year. He also considers the main challenges ahead, including the run up to Brexit, and shares his thoughts on where investors can uncover higher quality income opportunities.

A painful lesson for investors

2018 has been a volatile year for both equities and bonds. And it’s delivered a particularly painful lesson for many investors – fixed income assets can often fail to act defensively when equities experience losses.

This presents a challenge for investors as they typically hold assets such as government bonds to offset losses in stocks. But this traditional stance may be consigned to history – for now at least. The reason is this year’s increasing move from quantitative easing to quantitative tightening – the gradual yet persistent roll-back of liquidity by Central Bank’s as they stop and unwind their monetary stimulus programmes.

As I go onto explain, in this environment, we believe that the best approach is to pick individual income opportunities from the bottom-up, rather than relying on these historic top-down relationships.

Brexit uncertainty to hit UK markets

As we get closer to Brexit completion, a question on the minds of many investors is: what’s next for UK markets?

The fact is there’s likely to be more market volatility to come. But our focus remains more on bottom-up security selection on a global basis rather than taking macro views, so we certainly believe there are still opportunities within the UK market.

However, to avoid gambling on the outcome of the Brexit negotiations we prefer a balanced approach of owning well-valued domestic stocks such as Next and Bovis along with international earners like Unilever and GSK. That should leave us less exposed to the toing and froing of news headlines and what often results in short-term market moves.

Time to de-risk?

At Investec Asset Management, we do worry about the impact of quantitative tightening as the relationship of returns between fixed income and equities with these stimulus programmes has been high over this cycle.

We also believe the likelihood of a recession by 2020 has increased markedly. So while it’s still OK to have some equity exposure, it could be a good idea for investors to think about gradually de-risking their portfolios.

Identifying higher quality income opportunities

For us, income is one of the more reliable ways of generating total returns. And historically, over the long-term, income has been responsible for a significant proportion of returns. However, with the future more uncertain, identifying higher quality income opportunities with more reliable income streams across asset classes could be a better way of seeking returns than searching for capital growth.

We therefore don’t think of the income component of an investment as being different to the capital side. And we believe there are currently selective opportunities among higher yielding stocks – particularly in US healthcare.

Portfolio construction with a focus on risk

In managing the Investec Diversified Income Fund, we think less about asset allocation in the traditional sense of bonds vs equities or regional equity exposure. Instead we focus more on the contribution of risk within the portfolio of different asset classes based on their behaviours. We classify all assets in three different categories:

Growth: equities, high yield bonds, EMD and property
Defensive: government bonds, index-linked and investment grade bonds
Uncorrelated assets: gold, infrastructure and insurance.

A high-yield bond behaves in a similar way to an equity so we classify them both as growth assets that tend to do well in periods of positive economic expansion.

We believe that constructing a portfolio on a contribution to risk basis is more robust than a net asset value (NAV) approach. Recently the Investec Diversified Income Fund has become more uncorrelated by reducing exposure to both duration and equities and relying on bottom-up security selection. And for now at Investec, the majority of our risk exposure is in developed markets across both growth and defensive assets.

For more information on how we seek to generate defensive returns within the Investec Diversified Income Fund, visit www.investecassetmanagement.com/DIF.

You can also access the Investec Diversified Income Fund and wide range of income funds on the Standard Life Wrap and Elevate platforms.

The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your client’s investment can go down as well as up and may be worth less than you paid in.

The information here has been provided by Investec and is based on their understanding in November 2018.

Standard Life Aberdeen accepts no responsibility for the information contained in the websites referred to in this article. This is provided for general information only.

 

Image of Jason Borbora

Jason Borbora, Assistant Portfolio Manager, Investec Diversified Income Fund

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