Income-seeking investors have faced headwinds in the aftermath of the global financial crisis. With interest rates trapped at historic lows. Likewise, yields gained from bonds are near record lows, and the current market environment also provides an additional challenge to those who may wish to hold bonds for income: interest rates are likely to go only one way from here.
Should interest rates indeed rise, bond holders could see their capital diminish.
This comes at a time when demand for income has been rising; a large proportion of the UK population requires income in one form or another.
This has been accentuated by the Baby Boomer generation edging towards retirement age; at the same time, a change in UK regulations introduced in April 2015 gave people greater access to their pensions, presenting new choices in how to manage their money.
What investors typically seek are varying degrees of growth, income and risk from their investments; but delivering a good blend of capital growth and income whilst also diversifying risk can be challenging.
Over the past 10 years, not many equity markets have managed to achieve a total return in excess of cash1 +5% – the amount that has typically represented the potential return that investing in equities gives you compared with a lower risk alternative such as cash.
Likewise, neither bonds nor equities have consistently delivered an income above UK cash rates¹ over the past 30 years, which puts ‘real’ (inflation-adjusted) income levels under pressure.
Traditional ways of achieving diversification, such as combining bonds and equities into a single portfolio, may no longer provide sufficient diversification.
Traditional ways of achieving diversification, such as combining bonds and equities into a single portfolio, may no longer provide sufficient diversification; recent years have shown that bonds and equities are not always negatively correlated.
At Invesco, we believe the solution to overcoming these investment challenges lies in the ability to generate a reasonable income without embedding excessive capital risk within a portfolio. This belief formed the foundation for the Invesco Global Targeted Income Fund (UK).
The fund aims to deliver a gross income of UK 3-month LIBOR + 3.5%2 per annum whilst seeking to preserve capital3 over a rolling 3-year period and it aims to achieve this with less than half the volatility of global equities4 over the same time frame. There is no guarantee that the Fund will achieve these aims and an investor may not get back the full amount invested, as capital is at risk.
In our view, keeping a keen eye on our aim of capital preservation is important. Income-seeking portfolios can be prone to capital erosion – primarily due to two issues: excessive risk-taking in the hunt for yield and the redemption of units to generate income, which could deplete capital through time.
The first issue is that the highest yielding assets globally are also the higher risk areas of fixed income. To achieve average cash rates relative to history, an investor would need to look at high yield corporate bonds just to match the income generated from a bank account in the past.
The second issue can arise when investors buy a growth fund rather than an income fund, and then cancel units as income is required; this exposes the investor to both market and fund timing issues.
Should both a growth fund and an income fund suffer a short-term set back, an investor of a growth fund (who cancelled units to receive income) will not be able to participate fully in a subsequent rebound. Conversely, the investor who invested in an income strategy can participate more in the upside because no units have been cancelled.
¹Cash is defined as UK 3-month LIBOR (The interest rate at which UK banks lend to each other for a period of three months)
²Before deduction of corporate tax
³Net of fees
4Represented by the MSCI World index
Author - Invesco Multi Asset team, Henley Investment Centre
Focus on Funds
This article was featured in the first edition of Focus on Funds magazine.
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The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.
The Invesco Global Targeted Income Fund (UK) makes significant use of financial derivatives (complex instruments) which will result in the fund being leveraged and may result in large fluctuations in the value of the fund. Leverage on certain types of transactions including derivatives may impair the fund’s liquidity, cause it to liquidate positions at unfavourable times or otherwise cause the fund not to achieve its intended objective. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested resulting in the fund being exposed to a greater loss than the initial investment.
The fund may be exposed to counterparty risk should an entity with which the fund does business become insolvent resulting in financial loss. This counterparty risk is reduced by the Manager, through the use of collateral management.
The securities that the fund invests in may not always make interest and other payments nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in market liquidity for the securities in which the Fund invests, may mean that the Fund may not be able to sell those securities at their true value. These risks increase where the Fund invests in high yield or lower credit quality bonds and where we use derivatives.
As one of the key objectives of the fund is to provide income, the ongoing charge is taken from capital rather than income. This can erode capital and reduce the potential for capital growth.
All data is as at 30.04.2018 and sourced from Invesco unless otherwise stated.
Invesco Asset Management Limited and Invesco Fund Managers Limited. Both issuing companies are authorised and regulated by the Financial Conduct Authority.
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.
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The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance. We do not provide advice or make recommendations about investments. If you have any doubts about the suitability of an investment, you should seek advice from a suitably qualified professional adviser.