Searching for income in the current environment
Jeff Brunton (Investment Director – Global Equities and Fixed Income)
A question many investors face is where to invest for sources of income when rates are so low. With the official cash rate on hold at 2.5% since August 2013, many investors are looking for income opportunities outside of term deposits.
Sources of income are available outside of term deposits and across the traditional risk spectrum through equities and listed property in the form of dividends, and through bonds and hybrids in the form of coupon payments for bonds held.
Equity income is designed for investors who wish to benefit from regular and reliable income with some of the capital gains available from equity investing.
While the prices of equities fluctuate in capital value in the shorter term, the success from equity income investing is about shutting out a focus on short-term price movements and the day-to-day news headlines and focusing on the income stream that a high-quality dividend-paying company can provide.
We are lucky to live in Australia which, on the whole, offers higher dividends than their global counterparts. In addition, Australian equity investors benefit from imputation credits, a type of credit that allows Australian corporates to pass on tax paid at the company level to shareholders, which effectively can be used to reduce income tax paid on dividends and ultimately can gross-up the dividend yield of the Australian Stock Exchange (ASX).
Corporate bond investing is an appealing way to access income, as these higher yielding securities help offer income by investing in the future of high quality financial and non-financial corporates.
Corporate bonds are traditionally considered lower down the risk spectrum than equities. Nevertheless, when exploring income investing from corporate bond issuance it is prudent to have a focus on investment grade credit. While the search for yield leaves many investors with choices surrounding how much risk to carry, it is important to invest in companies with strong corporate fundamentals where a normalisation of global growth could translate into signs of revenue and earnings growth.
In the current environment we have low government bond yields with the prospects of a normalising economic growth environment. This means that in the period ahead the yields on government bonds are expected to rise. As such, managing the duration of bonds that an investor holds is an important lever in successfully managing this rise.
Even though government bond yields are expected to rise in the period ahead, we expect government bond markets (and hence base yields) to remain relatively calm in the absence of a pick-up in cash-rate hikes, which we do not anticipate will occur until the latter part of 2014 or beyond.