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How to Build an Income-Paying Investment Portfolio

Do you want your investments to pay you a regular income? We ask Investec's John Stopford how to blend income-paying assets for a sustainable yield

Emma Wall 6 September, 2016 | 12:47AM

 

 

 

Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by John Stopford, Manager of the Investec Diversified Income Fund.

Hello, John.

John Stopford: Good morning.

Wall: So, we're doing a back to basics week this week and we're looking at investment education. You're an income manager and income is something that investors really want. It's difficult to find in current markets, but I thought we could start by talking about the types of assets that provide investors with an income.

Stopford: Okay. Great. So, income investing, as the name suggests, isn't restricted to a single asset class, although inevitably historically it's been fairly focused on fixed income, on bonds. So, a large proportion of the income universe includes things like government bonds, investment-grade corporate bonds, high-yielding corporate bonds, emerging market debt and so on. But a lot of those assets clearly have become quite low yielding courtesy of central banks, slower growth, lower inflation and so on. So, investors are inevitably forced to look further afield for income.

And so equity, which has been an income area for a long time, has become obviously an important component but also property and then more niche areas like listed infrastructure and so on. So, the income universe is incredibly broad and it's all about trying to find trade-offs. It's about trying to find an attractive trade-off between the yield you can earn but also the potential for capital growth and also the risks that you take with that. And a lot of the high-yielding areas are somewhat riskier, so trying to balance risk and yield and return is essentially what we're trying to do.

Wall: And as the name suggests and as you've alluded to there, diversified income means that you're looking for those income within those different pockets. How do you blend income assets for that maximum income payment with the sort of managed risk at the moment?

Stopford: Well, I think it's very important to have a clear objective so to know what you're trying to do. So, there are lots of different styles of income investing. Some people are focused much more on trying to chase capital growth with a bit of income. We're very much at the defensive end of the spectrum. So our primary objective is to do deliver a defensive total return, so not just income but scope for capital stability, capital growth with low volatility and ideally low drawdown characteristics.

And so, we're looking for much more defensive outcome but still paying an attractive but sustainable level of yield. So the kind of things we're trying to do, the first is, actually the advantage of having all of this choice is rather than building a portfolio of lumpy blocks of assets, actually picking individual securities which can help us meet those objectives, so assets that have attractive yields but also where those yields can be maintained or potentially grow, where they are well-priced, where they are supported by the economic environment and so on.

And then in terms of diversification, as you say, it's very important, I think, to try and blend assets that have different characteristics together. The danger is you're going to seek yield and first where you chase things that are unsustainable, so companies like Tesco or Barclays, for example, recently where dividend yield looked very high but it was because the company was in trouble and ultimately were going to cut its dividend. So that's clearly not sustainable. But also, if you're going for a lot of the high-yielding assets like property, like high-yield, to some extent like equity, they all tend to be very cyclical. So, if the economy is doing well, they do fine; if the economy does badly, they do badly.

So, you need to blend those assets, all those investments with securities with different characteristics, so things like government bonds that are perhaps more defensive or listed infrastructure which is more of a diversifier and so on and end up with a portfolio that has a blend of risks. So when some things are doing well, other things are maybe doing less well but they are turning to offset each other and lower the overall volatility for the return that you get.

Wall: And how has that blend changed over time because, as you said in your first answer, we've had this environment where bond yields have been pushed ever lower. Not that long ago you could get on a sort of less risky asset a 5% bond yield. That's just not the case anymore?

Stopford: That's true. But I think the advantage of looking at the portfolio from the bottom-up, so looking at individual assets rather than blocks of assets is typically within any asset class you can find more attractively-valued good quality assets that you can own. So, the overall yield on government bonds has clearly come down but we think there are areas within the market that are supported by ongoing central bank easing that still pay a reasonable yield within the context of government bonds.

It's all about making sure that you take full advantage of the breadth of choice that you have and then be flexible. So as opportunities arise, take advantage of them. So, earlier this year, high-yield bonds, high-yield corporate bonds, have sold off very dramatically as people were worried about the collapse in oil prices impacting particularly the energy sector in the U.S. but the whole U.S. high-yield market sold off and that created opportunities to pick up good quality businesses at decent yields.

Similarly, for a lot of the last couple of years emerging markets have been somewhere that people have avoided and that's meant that some of the better-quality markets there actually now look quite attractive. Interest rates are starting to come down, the inflation is falling. So government bonds in places like Indonesia, we think, are reasonably attractive on a hedge basis. So it's all about trying to balance yield, risk and return.

Wall: John, thank you very much.

Stopford: Pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Cisco Systems Inc34.25 USD1.48
Investec Diversified Income R Acc GBP1.24 GBP-0.02
Tritax Big Box146.40 GBX0.69-
About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk