In focus

Can you really invest sustainably and still get a good income?


Finding decent income and maintaining a clear conscience is a growing challenge for investors.

The reason is fairly straightforward: investors don’t want to invest in companies and countries that they perceive to be causing harm. It’s an ethical stance, but it’s also because those investors are questioning the prospects of certain industries. This has created a perception to some extent that being an ESG investor (focused on environmental, social and governance issues) is becoming incompatible with being an income investor. We don’t think that’s true.

We believe there are ways that income investors can make sure that their income is sustainable.

Take a multi-asset approach

A multi-asset approach enables investors to diversify their income sources.

It is possible to earn an attractive yield across the credit spectrum, emerging market bonds and in alternative assets like preferred shares, insurance-linked securities (ILS) and property. These assets have a different risk profile to traditional income assets like high yielding equities and government bonds. Diversification also allows investors to introduce strategies that target a better sustainable outcome, for example thematic investments like renewable energy equities or green bonds.

But it is not only a case of diversifying between asset classes; investors also need to think about the opportunities available to generate income within asset classes.

Looking at this another way, investors typically have to take on more risk in order to generate higher yields. That’s because higher yields compensate investors for higher risk. Investors can position portfolios in portions of the market with both higher income and stronger sustainability scores by combining established risk measures with new sustainable approaches that account for risk.

A multi-asset approach also allows for a broader range of ways by which the portfolio can exhibit sustainable characteristics. Ultimately, those companies which have a net negative impact on society or the environment will be considered to be less sustainable than those which have a net positive impact.

Sustainable investing, however, is more than just the provision and withdrawal of capital. Within equities, sustainability is better pursued through active ownership – engaging with company management for change – than through divestment.

Within credit, investors lend money to a company for the management to use in sustainable projects, or withdraw the lending if they fail to prove that they’re doing so.

Be flexible

A dynamic approach allows investors to protect the portfolio against valuation risk and take advantage of valuation opportunities, while also navigating the risks and opportunities that arise from business cycle uncertainty.

Starting yields are not always a good measure of future returns. In fact, a high starting yield can reflect greater risk associated with the investment.

It is therefore important to keep an eye on metrics such as payout ratios and dividend coverage (for equities) and interest coverage and EBITDA/debt ratios (for credit).

A dynamic approach allows investors to shift away from value traps where future dividends or coupons are at risk and into the areas where attractive yields are backed by strong fundamentals.

In addition to valuation risk, income strategies are exposed to changes in the economic cycle. Equities and corporate bonds are cyclical in nature and high income segments are exposed to dividend cuts and corporate defaults. A dynamic approach allows investors to navigate the economic cycle by shifting from cyclical into defensive strategies during the slowdown or recession phase and vice versa during the recovery and expansion phase of the cycle.

 

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