Outlook 2016: Multi-Asset Income
2015 has been a challenging year for asset prices; however, following large swings in government bond yields and the recent stockmarket sell-off, many income sources are offering attractive yields again.
- Demand for income remains high and many income sources now offer attractive yields.
- Economic cycles are diverging; active management of regional risks is required.
- High dividend stocks and high yield bonds1 could offer opportunities.
Demand for income strong
The demand for income remains global and structural, driven by low interest rates and by an ageing global population.
Despite this ongoing demand, the environment has been challenging for income strategies.
First, the appreciation of the dollar is impacting liquidity and some interest rate sensitive assets.
Second, the normalisation of real rates2 took place as inflation expectations dropped both in the US and
Europe. Real rates are used to assess financial asset prices - if they increase, growth needs to be strong enough to offset this negative effect.
So what should we expect going forward? Investors will have to adapt to a fast changing environment as valuation may not be a sufficient guarantee of a successful investment strategy.
Regional divergences are more apparent
Global economic cycles are diverging across regions and are expected to continue to do so in 2016.
Recent divergences have been mostly driven by exchange rates and central banks’ guidance.
As such, we favour regional assets in Europe and Japan, which are both supported by loose monetary policies.
Europe is now accelerating thanks to a weaker euro.
Elsewhere, there are some signs of slowdown in the US manufacturing sectors whilst emerging economies remain under the stress of a strong dollar and decelerating Chinese growth.
The Federal Reserve (Fed) is expected to raise its key rates.
However, regardless of the timing of the first hike, this cycle is unique and the Fed may lack room for manoeuvre in the future and could reverse its course of action if imbalances grow.
High dividend stocks could offer some defensive characteristics with more regular and robust cash flows.
Typically, tighter monetary policy tends to generate lower expected returns and this requires investors not only to focus on total return3 but also on strategies which are dynamically managed.
For this reason, we expect volatility to normalise higher.
Asset prices will be more dependent on growth coming through in order to deliver future returns, whilst fair-to-expensive long-term valuation levels may cap equity price appreciation.
High dividend stocks and high yield bonds look attractive
In this context, high dividend stocks could offer some defensive characteristics with more regular and robust cash flows.
They have been underperforming for more than two years versus a standard global equity universe and could now offer an attractive entry point.
The first rate hike by the Fed in the coming months is not likely to be followed by an aggressive tightening cycle.
We are also finding some value in high yielding bonds although security selection matters. It is our preferred fixed income asset class given the attractive yield and high implied default rate4.
Regarding emerging market assets, we are cautious despite attractive valuation because of a strong dollar and a low growth environment.
Central banks and real rates will remain key drivers in 2016.
The first rate hike by the Fed in the coming months is not likely to be followed by an aggressive tightening cycle because of the dollar appreciation impacting US exports and of a weak Chinese growth.
Government bonds are therefore unlikely to run out of control but are unlikely to offer attractive returns. This could benefit actively managed income strategies.
Past Performance is not a guide to future performance and may not be repeated.
The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
1. High yield bonds are speculative bonds with a credit rating below investment grade.↩
2. The real rate is the rate of interest an investor can expect to receive after allowing for inflation.↩
3. The total return on an investment includes any capital appreciation (or depreciation) plus any income from interest or dividends.↩
4. Default risk is the risk that a bond issuer will not be able to meet its debt repayments and may default on its contractual obligation to investors. A high implied default rate means market prices suggest that the risk of default is high.↩
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