IN FOCUS6-8 min read

Yield hunting in an uncertain world

Falling interest rates, economic contraction and dividend cuts represent unwelcome challenges for income investors. Lateral thinking is needed to solve the yield conundrum.

18/05/2020
Eggs_basket_broken_hero

Authors

Ben Popatlal
Multi-Asset Strategist

For many years, ‘risk-free’ income from government bonds has been practically non-existent, forcing investors into higher risk assets such as equities and lower grade credit in search of more attractive yields. This problem, in the midst of a global coronavirus crisis, is about to get much worse for income seekers. In the near term, earnings are expected to fall dramatically due to businesses being temporarily closed as a result of government-mandated shutdowns.

Typically, dividend cuts follow earnings lower during recessions. This time round, investors are clearly fearing the worst, with the futures market anticipating a huge drop in European and UK dividends. In addition, US companies are likely to reduce or suspend share buybacks, a popular and tax efficient means of returning wealth to shareholders by reducing the share count and boosting earnings per share.

For equity investors across the world, an additional feature of aftermath of the coronavirus crisis is likely to be companies supporting their balance sheets by choosing to issue equity rather than debt. This is effectively a buyback in reverse, boosting the number of shares outstanding and diluting earning per share.  

Concentration risk looms too

Some investors will understandably look for the companies that still offer dividends or those where dividends have suffered fewer cuts. Unfortunately, this can then result in further issues – concentrating investments in just a few companies or sectors.

In addition, a number of sectors look worryingly over-stretched in terms of how much debt companies have on their balance sheets compared to history. This leads to legitimate questions about how viable a number of these businesses will be in a post-Covid-19 world.

Things are likely to get worse. The approach to managing an exit from the Covid-19 shutdowns is not yet clear and it seems likely that global businesses will be forced to adopt a more conservative financial approach to get through this period by protecting their balance sheets. As a result, more widespread cuts or suspensions to stock dividends could follow.

How should we invest for income in this environment?

Investors have two options available to them in this environment: chase a diminishing pool of developed market dividends or broaden their scope across asset classes with higher and more secure income. In the multi-asset team, we have always preferred the latter approach.

In this environment, we prefer securities with fixed rather than discretionary distributions and those that are higher up in the capital structure (so more likely to get paid) – see the diagram below. Examples in our portfolios are high quality credit, preferred securities, real estate investment trusts (REITs) and convertible bonds.

20200518_hk_eng_chart_1

In addition, it is important to broaden the investment horizon, by looking globally for income opportunities. From an equity perspective, we believe that Asia, for example, currently looks more attractive from a yield perspective, and the continent has also come through the Covid-19 crisis relatively unscathed.

Across regions, global market sector leaders, with robust balance sheets and conservative financial profiles, also look set to benefit from increased defaults among more leveraged competitors.

4 key takeaways for income investors

The search for sustainable income in the current environment can be daunting, but opportunities are clearly emerging.

There are four key lessons this analysis shows us about investing for income in this environment:

  1. A broad and diversified approach is required to avoid concentration risk
  2. Tilt to quality and market leaders
  3. Consider moving up the capital structure, favouring fixed as opposed to discretionary payouts
  4. Expand the universe geographically and by asset class

Looking ahead, we think that in the turbulent and uncertain aftermath of the coronavirus crisis, being nimble and fleet-footed will be the best way to protect investors’ income streams.

Important Information

The contents of this document may not be reproduced or distributed in any manner without prior permission.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.

Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.

This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Authors

Ben Popatlal
Multi-Asset Strategist

Topics

Follow us

Contact Us

Level 33, Two Pacific Place, 88 Queensway, Hong Kong

(852) 2521 1633

Online enquiry: Please complete the web form below and we will reply as soon as possible.

Contact us

The investments mentioned in this website may not be suitable to all investors. The information contained in this website is provided for reference only and does not constitute any investment advice. Investors are advised to seek independent advice before making any investment decision.

Investment involves risk. Past performance is not indicative of future performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Please refer to the relevant offering document including the risk factors.

This website is intended for Hong Kong residents only. Non-Hong Kong residents are responsible for observing all applicable laws and regulations of their relevant jurisdictions before proceeding to access the information contained herein. Schroder Investment Management (Hong Kong) Limited is regulated by the SFC. The website (excluding Schroder Provident Plan related pages) has not been reviewed by the SFC.

The website is issued by Schroder Investment Management (Hong Kong) Limited.

Important notice: Schroders does not make unsolicited requests through emails, calls, messages, WhatsApp, WeChat, Facebook, Instagram applications. Any contact other than via Schroders’ official channels for personal or financial information is likely to be false and fraudulent. Please stay vigilant and refer to our Fraud Alert Notice for further details. If you have doubts about the person, platforms, websites or institutions that claim to be associated with Schroders, please contact us via (852) 2521 1633 and inform the local police.