One of the main dangers facing income investors is that seemingly every yielding-asset has become expensive thanks to ultra-low interest rates and quantitative easing – and if the US Federal Reserve were to start raising interest rates this year it could cause the prices of those securities to fall dramatically.
In fact, in an article on Thursday, FE Trustnet spoke to a panel of financial professionals about the dangers of relying on multi-asset income funds when traditional securities such as government bonds and blue-chip dividend payers are no longer off the yields they as they once did.
Performance of sectors over 5yrs
Source: FE Analytics
However, JP Morgan’s Talib Sheikh (pictured), who co-runs the five FE Crown-rated JP Morgan Multi-Asset Income fund, believes that investors are fearing the worst when it comes to the impending rate hikes, reasoning that even when the Fed does move, rates will stay lower than in previous cycles.
Over the past three cycles, the multi-asset fund manager points out that the Fed began hiking rates when the fed funds rate was an average 2.9 per cent and ended when rates averaged 5.9 per cent. Now, he says the Fed’s current projections point to just a 3.1 per cent policy rate at the end of 2017. 
“I think people have to re-calibrate their expectations about a couple of things,” he said.
“One is where trend growth is – it’s much lower growth after the great financial crisis, so that means growth is likely to be lower going forward. It also means that interest rates are likely to be lower than they were pre-crisis.
“If we step back slightly, we’re five years into expansion, we’re the longest expansion the global economy has ever seen. I see no signs that it’s ending any time soon so that tells you we’re in a non-normal world post the financial crisis.”
“There are some global economies, particularly the US, that are healing, but we just disagree with the notion that the interest rate cycle is going to be things that we were used to pre-2008.”
As such, Sheikh and fellow co-manager Michael Schoenhaut have weighted 48.2 per cent of their fund in the US. This weighting consists primarily of financial equities, non-agency mortgages and high-yield investments.
“About half of the portfolio is in the US. That’s coming from the 28 per cent of the US weighting we have is in the high-yield [bond] market,” he explained.
“There’s a high-yield market in Europe, but we would argue that the drivers of positive growth within the US market are likely to be the same drivers that drive the equity market higher in Europe and we choose not to double up on that bet.”
However, the manager believes that exposure to high yield should be measured.
“Five years ago we had 50 per cent in high yield and the lowest we got down to was about 25 – at the moment it’s at 28, so we’re definitely at the lower end of where we want to be,” he said.
“We’re not hugely negative on high yield, but with a coupon of around 6.5 per cent, we see little opportunity for capital upside there.”
“However, we do feel that the global economy is slowly healing from those low levels – you could argue that equities offer the best chance of attractive yields and also potentially some capital upside from here.”
“It’s interesting, everyone knows that yield around the world or yield within fixed income assets has fallen post-the great financial crisis. I think what’s maybe under-appreciated is that the yields associated with the equity markets have actually gone up, so we do see corporates as generating large free cash flow. We do think that much of that will be returned to shareholders and we see potential for payout ratios to actually increase from here.”
However, Sheikh is steering clear from equities and high-yield credit in the commodities sector, as well as economies that are associated with them. This view primarily comes from his gloomy outlook on China’s economy and their attempt to shift their dependence from investment towards consumption.
“China are trying to move their economy on from one which is purely driven by fixed asset investment into one which is a bit more balanced. Over the long term they ultimately will be successful, but it means that the capacity or their need to import huge amounts of commodities is severely diminished,” he said.
“Some people are billing commodity stocks as the new utilities - they’re being run to generate cash flow and they’ve got attractive dividend yields, but we just don’t buy that at all.”
Where he is seeing opportunity, though, is non-agency mortgages, which are US residential mortgage securities not insured by governmental agencies. Because they’re backed by real estate loans that aren’t guaranteed by one of the listed agencies, however, they’re subject to default risk and have a lower level of credit safety.
However, Sheikh points out that this niche asset class also pays higher rates of interest and, with a knowledgeable team, they can boost a fund’s yield significantly. What’s more, they provide low duration sensitivity and have no exposure to the energy sector.
“In many ways, [non-agency mortgages] were the ones that caused the great financial crisis. That creates an opportunity for us because, frankly, any of those mortgages that were going to go into default would have done already, and in effect the asset class became distressed and were sold across the board – good bonds got sold off along with the bad bonds,” he explained.
“The other thing about them is, post-the financial crisis, they’re not really used anymore, so mortgages that don’t conform to that government criteria are not being originated and there’s not much supply. That’s what’s happening – people are actually starting to pay back those mortgages.
He added: “So, you’ve got no supply and a shrinking asset base as they’re being paid back, and that’s something that, as an investor, you find pretty attractive.”
While the US is arguably Sheikh’s ‘income comfort zone’ at the moment, his second biggest weighting is currently in Europe excluding the UK, which is a position that he and Schoenhau expanded into over a year ago, and is an area that they still have a high level of conviction in.
Performance of fund versus indices over 1yr
Source: FE Analytics
In fact, at their last allocation meeting, the team added further capital to Europe.
“There were a couple of reasons for that,” Sheikh said. “Number one and most importantly, in a fund that’s focused on distribution, we can build a portfolio of equities which yield around 4.5 per cent.”
“Number two, we believe the ECB are credible in their quantitative easing, producing monetary conditions that have been pretty ample.”
“Increasingly, and this really was the difference between our thinking on Europe today as opposed to six months or so ago, if you do see signs that the economic data is starting to improve, we believe that ultimately that will feed through to corporate earnings and that’s likely to mean that dividend yields are not only sustained at these levels, but actually corporates could increase the payout which is available. We think that’s pretty credible.”
However, many investors would point out that this dependence on quantitative easing is tenuous as it will only continue for a finite amount of time.
This begs the question: when QE subsides, will Europe still hold the same shine?
“I guess it depends on why QE is subsiding,” the manager said. “The ECB has made a commitment to continue QE into 2016 and I see no reason for that to change. The thing that could potentially derail that would be a rapid acceleration or, perhaps more worryingly from an asset point of view, a rapid acceleration of inflation across the region. In our assessment, that looks relatively unlikely.”
“The thing about QE globally is that it’s forcing investors out of the safest asset classes globally. So firstly cash deposits then government bonds then short-dated investment-grade credit. That’s the whole point of QE, to force people to take more risks with their portfolios.”
“Clearly not everybody wants to do that and I think that’s one of the things that the multi-asset income fund gives – it gives a more diversified approach to delivering a sustainable level of dividends.”
According to FE Analytics, the £400m JP Morgan Multi-Asset Income has been a top quartile performer in the IA Mixed Investment 20%-60% Shares sector since its launch in June 2009 with returns of 75.02 per cent.
Performance of fund versus sector and index since launch
Source: FE Analytics
It has a clean ongoing charges figure of 0.83 per cent and currently yields 3.73 per cent.