David Jane from Premier Miton’s Macro Thematic Multi Asset Team looks at the importance of rediscovering income strategies that were once the bedrock of the UK retail funds industry.
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.
A trend from the 70’s?
Income strategies at one time were the bedrock of the UK retail funds industry, particularly before the QE era emerged. They had, however, been in decline for some time prior to that. There are multiple reasons for the decline but also a number of very strong reasons why they will re-emerge over the coming years.
Income strategies were popular in the UK for many years, especially during the periods of higher inflation in the 70’s and 80’s. Inflationary environments tend to favour income (and value generally), as an investment style as they tend to go along with higher interest rates. Higher inflation has now returned and income styles will again need to be considered carefully as a consequence.
Another reason for a preference for income, was the dividend tax credit for pension schemes, which meant dividend income was especially attractive to UK pension funds and led dividend paying UK equities to form the bedrock of the UK’s highly successful final salary pension system.
The dividend tax credit was scrapped in 1999, greatly changing investors preference between income and capital gain, but also putting huge financial pressure on the pension system and ultimately leading to most companies scrapping their final salary schemes. Again, this is also now changing, recent changes to CGT rules means the relative attraction of income is returning.
Good buy Mr. Bond?
A further factor leading to the demise of the retail equity income strategy was the emergence of corporate bonds as an asset class, and ultimately as a retail funds product. M&G launched the first corporate bond fund in 1994, and this offered a lower risk income generating strategy than the more volatile equity income funds, giving income seeking investors a viable alternative. With yields falling consistently over the subsequent decades, bonds offered attractive yields and the prospect of capital gains. This has recently reversed, with capital losses the norm over recent years.
Because of these changes, fund managers running equity income funds changed their focus. Previously, many, if not most, had focussed on growing the income stream on their funds, a steady and growing income stream had been a major selling point.
One final change sealed this. The emerging focus on relative total return. Managers were increasingly judged on one- and three-year total returns, which ignored income as a metric. Income managers felt pressurised to manage total returns versus the sector and, hence, were increasingly drawn to growth as a style, which was outperforming in the falling inflation environment.
This is all set to change. Pension freedoms have driven large numbers of investors into SIPPs and a huge number of these clients are now nearing or entering retirement. These investors will naturally be looking for a consistent and growing income to replace their lost salary.
Unit encashment had been favoured to meet this need, particularly as growth styles of investment were performing well during the low inflation period. This approach comes with a number of huge drawbacks, particularly if the market environment is weak in the early years post-retirement.
Consumer duty also comes into play here, clients are asking for a regular income to fund their outgoings, providing this directly is the obvious answer, rather than hoping for rising markets to provide gains to realise to provide income.
One benefit of the changes over the past decades is that income funds no longer need to focus solely on UK equities or even equities at all. Widening the universe to global equities massively increases the opportunity set. Broadening further into a truly multi asset income approach really makes providing a consistent growing monthly income a real possibility in a mixed asset fund.
The final word
One obvious problem is that there are no longer many managers that focus on income and income growth as a strategy. There are many funds that have income in their name but for the most part they are focussed on the sector definition, in the case of the UK, having a yield not materially below that of the UK market.
We think in the future many managers will be rushing to brush up their income management skills as client demand and investment returns drive money into truly income focussed funds.