20th November 2015
The race for income is intensifying following pension freedom but there are three pitfalls that investors need to be aware of.
Justin Onuekwusi, lead fund manager on the £700 million Legal and General Investment Management Multi Index and Multi Index Income fund range said investors on the hunt for income should be careful.
1. Chasing yields
The major issue with chasing income is the ‘complex relationship between yields and risk,’ said Onuekwusi.
‘Over the long-term, higher risk assets have a higher expected return to compensate investors for the greater risk they are taking,’ he said. ‘Returns on an asset can either come from capital growth or income and the proportion of each type of return for each asset is not the same.
‘Some high-risk assets have high expected capital growth and a low yield and others may have low capital return and a high yield.’
He said an efficient portfolio is one that ‘maximises returns for a given level of risk’ and if a portfolio is composed of high-yielding assets it is ‘inefficient’ because it is either taking too much risk for the return or it is not delivering enough return for the risk being taken.
‘It is possible to tilt a portfolio so a greater proportion of the return is derived from income whilst not losing sight of maintaining proper diversification and portfolio efficiency,’ he said.
2. The wrong target
Targeting high yields in order to sustain high income can lead to unsuitable portfolios and high volatility.
‘If the objective of a fund is to target a level of yield then as the yields available in the market change, the amount of risk the portfolio takes as a consequence must be variable,’ said Onuekwusi.
‘The end result is the portfolio may drift across risk profiles as the fund seeks to maintain its yield target. Intermediaries strive quite rightly to ensure that funds are suitable for their clients’ attitude to risk and capacity for loss. If a fund does not have broad risk stability then the intermediary must remain vigilant in monitoring whether that investment becomes unsuitable for their client base.’
The introduction of pension freedoms has meant more investors are putting their money in multi-asset income funds. However, investors should be aware of the fees they are paying.
‘We all know fees will always detract from an investor’s pot needed to generate income,’ said Onuekwusi.
‘The higher the fees all things being equal, the faster the pot will erode over time. If you have built a well-diversified income portfolio that is matched to the right risk profile, the last thing customers want is for that investment to be eaten away at by high fees.’
He added that this has even greater significance considering investors are living longer than ever and need their pension pot to stretch over more years. The pension could also be required to stretch beyond the retiree’s lifetime as pension freedoms have made it easier to pass on money to the next generation.