How asset managers can help achieve your income goals

Income is a top objective for many investors. Whether it’s to provide for retirement, pay school fees, or simply the desire to see a tangible return, many people name income as the main outcome they want to achieve by investing.

However, most people overestimate what their current investments can provide. With bank savings rates at record lows, people need expert help to obtain higher income reliably from other sources.

Reliable income was easy in the past

Historically in the developed world, those looking to obtain an income from savings would deposit their money in a savings account or purchase government bonds. It is not difficult to see why: as an example, UK nominal interest rates were held between 11-12% for much of the 1980s, and above 5% from 1990 until 2008.

It is true inflation remained at a persistently high level throughout this period. Despite this, positive and high real (i.e. inflation-adjusted) rates were not an uncommon phenomenon throughout the developed world.

Consequently, cash savings seemed very attractive, and government bond yields were high. Savers were more than happy to rely on these sources for income, and did not need to take any additional risk with their capital.

Why do these sources no longer provide an attractive income?

The Global Financial Crisis (GFC) brought about unprecedented change that arguably sounded the end for such savings products as a sole source of income.

Plummeting growth and the drying up of credit forced the hand of central banks. Interest rates were cut to record lows in an attempt to encourage banks to lend and to restart the economy.

In addition, multiple central banks embarked on quantitative easing (QE) in an attempt to lower rates further and boost liquidity. Under QE, central banks have purchased mainly government bonds, driving up bond prices. Bond prices and yields have an inverse relationship, and therefore bond yields have fallen to historic lows. As a result, government bonds do not provide the income that they once did.

To put things into perspective, Japanese 30-year bonds currently yield 0.85% which, on a 30-year investment, is far from an appealing income.

Unsurprisingly, plummeting base rates have in turn taken their toll on rates offered by banks. The impact of this is clear: the average rate for UK savings accounts is 1.23% and just 0.06% in the US.

Making the situation worse, these are nominal returns. Considering inflation in the UK is currently 3.0% (2.2% in the US), the inflation-adjusted return on many, if not all, accounts is negative. In other words, money sitting in the bank declines in value.

Pictured below, this 1986 UK National Savings certificate - providing a guaranteed tax-free 8.75% per annum - comes from a very different time. Note: UK inflation was 3.4% in 1986.

Interest rates are beginning to rise

The global economy has staged a recovery since the GFC and the result is that interest rates are now starting to rise in many countries. The US led the way but others are following suit.

Central bank balance sheets swollen by QE will also see a reduction in the near future. Central banks will reduce reinvestment of the proceeds of maturing debt securities, and begin tapering bond purchases. Subsequently, bank savings may become more appealing again as rates rise, as will government bonds as yields begin climbing.

Historical rates were not “normal”

However, potential interest rate increases should not be exaggerated. Changes are likely to be gradual which means rates will remain exceptionally low by recent historical standards.

More significantly, investors waiting for a return to the “‘normality’” of high base rates and bond yields are likely to be disappointed. In fact, the interest rates between 1970 and 2008 should be viewed as highly abnormal when viewed over a longer time frame, as demonstrated below.

Given structural changes such as demographics and productivity, rates are unlikely to return to levels that would generate sufficient income for investors relying on cash savings.

Since interest rates and bond yields move in the same direction, we think bond yields are also unlikely to reach levels seen between 1970 and 2008. It is therefore improbable that yields will entice investors back towards government bonds as a sole source of income.

However, demand for income has not gone away. The 2016 Schroders Global Investor Study highlighted that a significant majority (87%) of investors are seeking an income of at least 4% in order to compensate for inflation. A smaller but still large proportion is looking to achieve even greater returns.

Rates unlikely to meet clients' requirements

Asset managers offer range of income solutions

Individuals need to cast their net wider into riskier asset classes to achieve higher income. Examples of such asset classes are equities, corporate bonds, property, and multi-asset solutions. However, these assets are often unfamiliar and come with lots of different risks that individuals may not be able to manage on their own.

Sustainable income, in particular, is difficult for individuals to achieve. For example, it’s easy to buy a stock offering a 4% dividend yield but what happens if the company cuts its dividend? What if the share price falls?

Where an asset manager can help is in offering solutions that allow investors to access these higher income-generating assets, while at the same time helping to manage the risks involved.

Markets fluctuate from day to day, meaning the value of an investor’s pot of capital will also fluctuate. Asset managers have the expertise to manage these risks, for example by investing in a variety of assets or in different geographies.

The most important part of managing risk, however, is taking a long-term view. Investors seeking higher levels of income will need to be prepared for short-term changes in the value of their capital if they are to access higher sustainable returns in the long-run.

This is in contrast to cash deposits which are often guaranteed up to a certain value (e.g. £85,000 in the UK). That said, as we saw above, leaving capital in savings accounts is not risk free either as the value is being eroded by inflation.

The sectors, securities, regions and countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.