Institutions Shift to Higher Yielding Assets
10 Aug 2012
With 65% of Asian institutional investors reporting a decline in income yield in the past five years, demand has increased for a greater range of assets offering higher yields.
According to a new report issued by Fidelity Worldwide Investment, investors are making an active shift to boost investment income. The report, entitled ‘The Age of Income', suggests investors are set to make active changes to increase investment income over the next five years. Respondents to the survey, which was carried out by Greenwich Associates, say they are planning to turn to high-dividend equities and investment grade bonds as these assets provide the most favourable trade-off between income and risk.
"A rolling financial crisis, economic dislocation and consequent market volatility have reduced institutional investor confidence in the likelihood they will benefit from capital appreciation," says Chris McNickle, Global Head of Institutional Business at Fidelity. "This has increased the importance of income, but it comes at a time of historic low interest rates and a sharp rise in the perception of the risks involved in certain investments traditionally associated with income generation. So investors are searching for income in other places," he continued.
Asian institutions showed a concurrent willingness to gradually shift sources of income up the traditional risk spectrum. More than 55% of them are expected to increase their exposure to European and US investment-grade bonds in the next five years. Over four in ten (44%) of Asian respondents plan to raise their asset allocation to emerging market investment-grade bonds, with a similar proportion planning to increase exposure to equities with high dividend yields.
The Age Of Income report highlights the sustainability of dividends as key and suggests that dividend-paying stocks can represent a sensible diversification for income-focused investors. The extra returns from dividends can provide a valuable margin of safety against price declines if volatility continues.
Dividends also provide an income stream that grows in real terms and broadly protects against inflation. The report suggests there are many opportunities for investors to find attractive income by focusing on high-quality issuers or by taking a flexible approach to bond investing that avoids the concentration risk in aggregate benchmarks. Countries with sound fiscal management, such as Canada and Australia, and companies with strong free cash flow are perceived as better bets than many traditional sources of income. Property investments also provide a source of stable income among investors who can sacrifice short-term liquidity. Yields on properties with long-term leases held by tenants who are good credit risks can generate income in excess of more liquid sources—a positive trade-off for long-term investors.
Managing the risks inherent in the various sources of income all require in depth research and analysis—to ensure income streams are sustainable and credit quality sound. Almost half of institutions surveyed believe low interest rates will be the key driver of shortfalls in income over the next five years. Other factors sighted by respondents include credit spreads and dividend yields. When it comes to the sources of risk to principal, Asian institutions are most wary of equity market risk, 44%, followed by interest rate risk at 41% and credit/sovereign risk at 37% respectively.
By blending different asset classes, a dynamic multi-asset approach can deliver lower variability of yield and capital, and diversify sources of risk. Risk-parity portfolios are an interesting example and provide one elegant solution to this trade-off.
Mark Talbot, Managing Director Asia ex Japan at Fidelity Worldwide Investment, said, "The search for income is already a powerful investment theme but it is one that we expect to grow in importance over the next decade. Investors are reassessing their strategies as it becomes clear the world economy is in the midst of a fundamental restructuring. Secular growth drivers are reshaping the balance of economic power; the demographics of longevity and aging populations are intensifying the retirement saving imperative; while the financial risk environment has been transformed by the 2008 credit crisis and the ongoing sovereign debt crisis.
Not only is income expected to be a more important driver of returns, going forward, Fidelity sees clear evidence that institutions are considering a wider range of assets to meet their income needs. In this environment, flexible fixed income portfolios, quality-focused equity dividend portfolios and commercial real estate portfolios can offer greater yields, without necessarily taking on significantly higher risk. Talbot says, "For investors looking for an attractive compromise between stable yield and managed volatility without the concentration risks to capital reliance on a single asset class entails, a risk aware multi-asset approach can offer a compelling solution."
The full results of the survey can be found in the Fidelity White Paper: "The Age of Income: www.fidelity.com.hk/investor/en/about-fidelity/press-release.page?articleId=h53xts6v&ArticleCategory=5
Author: Richard Newell