Why time, not markets, is the biggest risk for income investors

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Taking a long-term focus

In an environment of rising volatility, negative political headlines and rising interest rates, it is understandable why investors may be feeling cautious. However rather than panic, Rupert Rucker, Head of Income Solutions at Schroders, says investors need to ignore the short-term noise and focus on the long term.

After a period of calm in 2017, markets have been more volatile to date this year and Rucker says in the view of Schroders there is set to be inherently more volatility in the years to come.

“Over one-to-three years there could well be more market dislocations,” he says. “In this sense, time is really the biggest risk for investors. If they are not prepared to commit to an investment for long enough, they will instead have to keep their money on deposit and earn very little.”

However, Rucker argues that if investors remain invested for at least five years, they can ride out these short-term capital dislocations and still earn a good income.

Brave new world

At the same time as volatility is rising, so too are interest rates. In the US this process is already under way, while after one rate hike last year, the expectation is for rates to rise in the UK as well.

However as long as the main traditional providers of income – namely bank deposits and government bonds – no longer can provide a decent income for investors, Rucker says the interest rate environment is pretty much irrelevant.

“While rates have gone up a little, our assumption is that they will settle at a level which is still way below most investors’ income expectations,” he says. “If banks are not going to offer 4-5% on deposit, and government bonds are also not providing this, investors will have to risk their capital. This is the new world.

“We have been living with this situation for a number of years, but our feeling is that many investors still expect interest rates to return to where they were in the past. We don’t think they will, and on this basis if investors want income they will have to be decisive and risk their capital.”

Risk equals reward

With some 36 different income solutions on offer, Schroders has the range covered when it comes to client needs. At the lower end of the risk scale it has products targeting yields between 2-3%, others that aim for 4-5% - which Rucker notes appears to be the sweet spot for what investors want – and then it has higher income solutions which strive for yields between 6-7%.

“To get this 6-7% income you obviously need to take more risk,” says Rucker. “However again the risk is time. We can pay 7% on some of our equity and high yield bond funds, but both equities and high yield are volatile.

“At the same time, there are many companies that are overvalued at present. Our skill is to find those across the globe that offer good value as well as sustainable or growing yields. It is hard work and requires adopting a global view and conducting bottom up analysis and then both patience and time from the investor point of view.”

Indeed owing to the rise in volatility stemming from short-term noise, Rucker notes there are more income opportunities today than there were six months ago for those investors properly able to analyse markets. For example he says Schroders has the ability to look through political events such as Brexit.

“If a company, on either the equity or bond side, is in decent shape and we think it offers good value and the income look sustainable, we can look right though Brexit or anything that Donald Trump tweets,” he says. “This is because we take a five-year view and look at what the company is doing, not what the current noise is.”

Seen it all before

With a track record of income investing stretching back some 30 years, Rucker says the team, at Schroders has garnered experience throughout different market cycles.

“We have ridden many cycles before and in the process we have learnt that we cannot possibly forecast what will happen,” he says. “What we have learnt is not to panic and how to package solutions and diversify sensibly.

“This is all embedded in the value we offer. We recognise that we are not unique, but we offer a very high-quality service and with some 36 different offices and 700 investment professionals we have the resources to be around for the next 200 years.”

Rupert Rucker is Head of Income Solutions within Schroders’ Income strategic capability