17th June 2013
Psigma’s chief investment officer Tom Becket has set out how he believes the fund will generate income in what some are calling a yield free world without concentrating risk.
In a note issued today, Becket points out that UK interest rates are at a 200 year low and there have been 510 interest rate cuts by the world’s central banks since 2008/2009 with recent “slashers” including a real variety of countries and regions, such as Europe, Australia and Korea.
The most lasting impact of the central bankers’ Zero Interest Rate Policy has been a significant re-pricing of any investment with a yield.
“Investors and savers are desperate for income and the clamour for yield has driven many assets to unrealistically high valuations. This has meant that we have had to be dynamic with our asset allocations over the last few years and a key reason why we employ a “forward looking” investment process,” he says.
Becket notes that quantitative easing has had an incredible impact on government bond yield “Ten year yields having been well below 2% for much of the last two years in Germany, Switzerland, US, Japan and the UK, for the most part offering investors sub-inflation returns or “negative real yields”, rendering them un-investable to us at least. Some are debating when the ultra-easy monetary policy might end, but we have learnt in recent years that central bankers are likely to try and print too much new money, rather than too little, and this pressure upon income seems set to stay with us for some time to come.”
Investors have therefore been pushed out along the “risk curve” in search of attractive yields, starting with government bonds, through all types of corporate credit and now in to real estate and equities. It has set this out in the following table.
The Suppression of Risk Premia (Source: Psigma IM)
The conditions also mean many traditional corporate credit markets are also unattractive.
“Yields are at the lowest ever levels, as evidenced by the US High Yield Bond Index yield falling below 5% in May for the first time in its history. Such investments now present very high interest rate risk. In short, they will suffer when interest rates finally start to rise, impacting capital values. We have tried to shield our clients’ assets from the threat of rising rates by only owning short duration assets, where we can achieve yields of 4-5% with little interest rate risk as the bonds mature in under three years. Current favoured investments include the AXA Short Duration High Yield and AXA Emerging Market Bond funds.”
The firm has also created its own mandates. The note adds: “One such investment is the TwentyFour Focus Bond fund that we structured in early 2012. The unique nature of this fund is that all of the bonds that the fund invests in will redeem within three to four years. This “finite” life of the fund does, we believe, considerably reduce “duration risk” and offers a reasonable degree of protection against the possibility of rising interest rates, whilst providing an income stream of c.7% per annum. We also recently seeded a small US corporate debt fund, Airlie Select US High Yield, which invests in bonds issued by smaller companies and generates a yield in excess of 9%.”
The fund has also invested in holdings that have floating rate coupons.
“Key holdings within our portfolios include the Neuberger Berman Floating Rate Investment Trust, which has a yield of 5.5% and the income is linked to interest rates, which will also go up when rates eventually rise. A similar investment would be the TwentyFour Asset Backed Income fund, which invests in very high quality European asset-backed securities and pays an income in excess of 8%, again with floating rate coupons. This fund was specifically created for our clients earlier this year and we believe that this is one of the most attractive opportunities currently available across global financial markets.”
Becket points out that in terms of equities a lot of money has been going into defensive stocks but this theme may be getting a little tired.
“The new money coming in to equity markets is mostly going to high quality “defensive” businesses, with strong balance sheets and healthy dividend yields. This has led to a rare phenomenon of “boring but worthy” sectors such as utilities, healthcare and consumer staples leading the market higher in the recent rally. We have had a high weighting to such investments over the last few years through our “defensive delights” theme, but we believe that now is the time to start reducing expensive investments such as these and to focus on better value, long term opportunities. We don’t believe that defensive equities will necessarily be bad performers in the years ahead, but we believe that their best days are behind them”.
The note then considers the following four investment opportunities.
Better Value Equity Income Strategies Exist
Reassuringly it is still possible in equity markets to buy globally diversified and balanced funds, such as our top pick Lazard Global Equity Income, with yields close to 5%. This fund is a key indicator of the value that still exists in equities, as the fund owns a collection of companies whose combined valuation is a moderate 11x earnings, with 10% annual earnings growth forecast by the manager. Such valuations are hardly expensive in our opinion. In the UK it is possible to buy traditional equity income funds with a covered call strategy, where the managers use simple derivatives to enhance their investors’ yield, such as Schroder Income Maximiser and RWC Enhanced Income, a recent Psigma selection, with yields of around 7%.
Emerging Income in Emerging Markets
It is not just in the developed world that investors can find companies with attractive dividend yields. If one wants to look to the exciting Asian markets there are funds, such as Prusik Asian Equity Income and Schroder Asian Income, where you can comfortably achieve yields in excess of 4% from a diversified selection of potentially high growth opportunities. In short, our income stream does not need to be solely secured from the mature world, and is globally diversified.
Looking to Alternative Markets for Income
If investors want to look to more niche investment opportunities there are new markets such as reinsurance bonds (Catastrophe Bonds), where investors can effectively lend money to insurance companies insuring against extreme natural catastrophes. These bonds are typically only triggered against 1 in 100 year type events and it is still possible to buy a diversified portfolio, such as the GAM FCM Cat Bond fund, with a yield of 8%.
Benefitting from the New Environment
We have also recently made a purchase in infrastructure assets, through the addition of GCP Infrastructure, an investment trust focussing on staple and stable assets, such as hospitals and schools. We believe there is a great opportunity to make positive uncorrelated returns from this fund, as well as an attractive yield. Demand for infrastructure assets is currently extremely high, as the worlds’ investors struggle for income in this low yield environment. This fund is a good example of how we can find opportunities to exploit in changing markets. Here, as investors, we are replacing the banks who used to lend to this sector but who now need to restrict/ conserve capital and can only lend small amounts. In return for lending to such infrastructure trusts, you can receive an income of c8.5% to 9%, with some inflation protection on certain contracts.
The note concludes: “Clearly the above are not cash substitutes, but hopefully we have demonstrated that it is still possible to put together a diversified portfolio of income producing assets in this era of “financial repression” and low interest rates. We are doing this without investing in illiquid investments and avoiding expensive traps, such as commercial property funds.”