We have focused a great deal recently on clients who are taking regular income. Where it is not crucial to someone’s lifestyle or wellbeing, we have broached the possibility of reducing or even stopping that income. Firstly, so as not to put more pressure on their investments in difficult times, but secondly, as Andrew explains below, natural income will certainly be more difficult to achieve in the near future at least. So, let’s look at how the investment management team is approaching managing an income portfolio in the current climate?
It is undoubtedly more challenging to manage income portfolios given the current global economic backdrop. For example, dividends from global equities are expected to fall somewhere between 15% and 30% this year. This is more pronounced in higher yielding regions such as Europe and in the UK in particular. The UK has historically been a country with one of the highest pay-out ratios and the fall in dividends could be as much as 50%, in a worst case scenario. This decrease in dividends from companies in the UK is largely due to the make-up of its stock market which is dominated by financials and commodity stocks. Some firms, such those within the energy sector, have been forced to cut their dividends due to the low oil price. The Bank of England has obliged banks to cut pay outs in order to preserve capital to help the economy, while the UK government has prohibited large corporations that have participated in its bailout loan scheme from paying dividends.
Yields have risen in our portfolios this year as asset prices have fallen. However, they are likely to fall back again as markets recover and as cuts to dividends are realised. Nonetheless, to mitigate this, we have exposure to fixed income funds as well as to equities. Fixed income assets carry a contractual obligation to pay interest as well as to repay the original sum loaned by an investor. Unfortunately, some companies will inevitably cease trading and will therefore default on their debt. However, we are confident that the managers of the funds we hold in our portfolios will be able to avoid most of these.
In addition, the equity funds that we invest in are well-diversified globally and we have a significant allocation to infrastructure funds. Infrastructure companies, such as utilities, are less vulnerable to an economic downturn and these holdings should be much more immune to cuts in dividends.
Given the market backdrop, it is unlikely that the portfolios will produce the same level of distributions this year as they have historically. Nonetheless, the diversification we have in place across assets and fund managers should provide a reasonable level of income protection.