David Jane
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Time to rethink retirement income?
At Premier Miton we are strong believers in the use of ‘natural income’, particularly for post- retirement clients. Rather than relying on the vagaries of asset prices. We think a much less risky strategy is to draw an income from a portfolio in the first instance. Whilst this may seem somewhat obvious it certainly has not been a popular approach in recent years.
We think there are two reasons for this. Firstly, we have only recently come out of a period of low inflation and low interest rates, in this environment growth strategies typically do well and income less well. Income funds fell out of favour and advisers became accustomed to using unit encashment to fulfill clients cash flow needs.
The other reason is arguably a consequence of the first, there are very few income funds that provide a reliable and consistent stream of income. Income managers have been judged on total return first and foremost. They have focused on this and possibly the fund’s yield but not on income distribution. This means advisers have few choices available if they want to provide a steady and growing stream of income to clients’ post-retirement.
Income obsessed
We think the job of a fund marketed as providing a reliable source of income is to prioritise the income. This means understanding the fund’s income receipts and distributions and forecasting them over time, rather than considering the fund’s yield, which many managers know.
We are often asked whether this obsession with income must come at the expense of total return and we don’t think this is the case whatsoever, in fact the discipline of managing income may provide an advantage over time.
To manage the income in a portfolio, we forecast the bond income (which is predictable), and the equity dividends (which are less predictable). We consider this in view of the income we need to produce to meet clients’ expectations. If there is a shortfall, we can take corrective action well in advance. This throws up all manner of opportunities, as it forces you to consider the real value of assets.
For this reason, we think that consideration of income gives an advantage in terms of total return, particularly in this new environment of higher rates and higher inflation. A couple of recent examples highlight this.
Trimming and tacking
During the covid crisis, a number of equities ceased their dividend payments as a result of economic uncertainty. At the same time bond yields fell precipitously, for the same reason. For an income manager, the lost income from cancelled payments was a problem. You needed to replace this income. With equities having fallen, and bonds having risen, the natural course of action was to buy more equities, funded by bonds. So, we sold government bonds at reduced yields to buy shares in those companies that were still paying attractive dividends. While we also sold shares where dividends were cancelled, net-net we found ourselves buying equity during those difficult times. With the benefit of hindsight this turned out to be a good decision
Another example would be the UK pension crisis last Autumn. Bond yields were driven higher, arguably because of forced selling, in a huge spike. As a consequence, some very attractive nominal yields were available for a period of time, in very good quality corporate bonds. We were able to lock in a high-quality source of income for several years into the future for unit holders. Again, this income driven opportunity led us to buy at what turned out to be very attractive prices.
The income advantage
These macro-opportunities are often repeated at an individual security level, where yield gives a signal that a bond or equity is mispriced for the long term, although in this case a great deal more care was required. High dividend yield can also be an indicator of future financial distress or the unviability of a business model. In our case we mitigate this with high levels of diversification and careful screening for leverage and other indicators as required.
In our view, an income strategy does not need to compromise total returns. Considering income can be an advantage, as it forces the manager to consider the real value of assets over time. In our view, the real long-term value of an asset is the cash it can return to its owners now and in the future.
