Many multi-asset income funds offer a risky ‘here-and-now’ strategy to investors which won’t be able sustain their high dividend yields over the coming years, according to David Coombs (pictured), who is aiming to deliver a lower yield in his recently launched Rathbone Strategic Income Portfolio to make sure his income pay-outs are sustainable. 
Coombs launched his new multi-asset income fund at the start of last month and there is little doubt it has turned out to be an increasingly popular area of the market over the past year or so with many other groups opening funds in the space to capitalise on the demand for income.
His fund differs from most, though, as it aims to provide a return that is 3 to 5 per cent above inflation over five years, has a risk budget of two-thirds of the volatility of the MSCI World index over a rolling three-year period, and has a minimum annual yield target of 3 per cent.
These defensive aims though are far from what the manager envisaged when he decided to set up the fund in 2013.
“If we’d have launched it two years ago it would have been a completely different fund,” Coombs said.
“Then it would have been a fund targeting the highest yield possible with lots of exposure to alternative income strategies, I think that’s what we envisaged at the time.”
The main reason the manager decided on this original fund structure was because of the expectation that interest rates would rise imminently and that bond yields would increase as a result. Of course two years later, interest rates remain near all-time lows and bond yields are at even lower levels than they were back then.
Performance of sectors over 2yrs
Source: FE Analytics
Because of this economic backdrop, Coombs decided to launch a different fund with far lower levels of risk, as he says he would be launching the fund into the headwind of the rising rate cycle and at a time when income-producing assets across bonds, equities and alternatives are overvalued.
He warns, however, that many of his peers will face a very tough time if they continue to try and deliver a high level of yield given the risks associated with the current market.
“While I could launch a fund with a yield north of 5.5 per cent if I wanted to today, I really don’t want to. The whole point about launching a fund is you want it to be relevant at any time in the cycle, and you want longevity within the strategy,” he said.
“You don’t want a here-and-now strategy which I worry some of these other income funds are, especially if interest rates rise too quickly over the next few years.”
As a result, Rathbone Strategic Income Portfolio has no exposure to high yield bonds, ‘bond proxy’ equities and holds virtually no alternative income strategies.
This contrasts with many investors’ views that, because ultra-loose monetary policy has caused equities and bonds to correlate, alternatives are a good way to add genuine diversification to a portfolio.
Performance of index vs sectors over 5yrs
Source: FE Analytics
In an article published last week, global asset management firm Natixis warned that advisers should be looking to buy into more alternatives to act as a portfolio safety net.
“Why aren’t advisers using alternatives more, particularly those that might offer real diversification benefits or returns?” Matthew Riley, head of research at Natixis, said.
Another reason that investors opt for alternatives is to generate higher yields, depending on the assets they are buying into.
Currently, Coombs’ new fund has a 4.5 per cent yield which he says is still low compared to his peers, but he believes that long-term sustainability and risk-adjustment is far more important than chasing as much income as possible.
“It looks predominantly like a vanilla bond and equities fund if I’m being honest at the moment, but obviously that could change over the next few years.”
“It’s not very sexy in terms of having lots of whizzes and bangs, and there are other multi-asset funds available out there that will have a lot more of that stuff in them, but we have none of that right now. No peer-to-peer lending, no infrastructure, no student accommodation. We think it all looks ridiculously expensive and the yields aren’t high enough for the risk you’re taking,” he explained.
“There might have been a lot of that in the fund a few years ago I suspect, I don’t know. The fund actually has a yield target prospectus which is a minimum yield of 3 per cent. People might either say that’s a bit low, or they could question why the target is so low compared to what the fund is yielding today.”
Coombs says that the reason the yield is so far above the fund’s target is simply because it is relevant to markets today and it will inevitably change over time.
If, for instance, interest rates get cut further and economies across the globe fall into deflation, he says that a yield target of 3 per cent will no longer seem low. While he doesn’t see this as a particularly likely scenario, he warns that it’s dangerous to rule out any situation as impossible
“It wasn’t just a benchmark we found easy to beat, that’s another thing a cynic might say. Of course beating 3 per cent isn’t very tough, we’re not saying it is, but if we got negative 1 per cent inflation over the next few years, 3 per cent will be pretty tough and that’s the point,” the manager continued.
“Then we have the risk budget which, like my other funds, is two-thirds equity risk, and a total return target of 3 to 5 per cent. This is unusual for an income fund and we have to maximise returns within this space.”
Currently, Rathbone Strategic Income Portfolio has a 53 per cent weighting in equities and is overweight in US and Japanese stocks. Despite many of these being large and mega-caps, the fund is at its maximum level of equity risk. The fund also has a 27 per cent weighting in corporate bonds, 10 per cent in government bonds and a small amount in property.
Because the fund doesn’t have to have a high income yield, Coombs says he has the freedom to choose better quality stocks and therefore isn’t forced into taking risks he doesn’t want to take.
Coomb’s current goal is to generate a strategy that’s going to perform well in a rising interest rate environment while also producing income, and as such he has opted for high-coupon, low-duration bonds in the fixed income section of his portfolio.
This means that this section is generating high levels of income for the fund but is also causing some capital erosion, which the manager aims to counteract through buying equities that have strong levels of growth and reliable balance sheets, but don’t necessarily have to pay a dividend yield.
“Once you take that pressure off you can start looking at every investment on its own merits and start building a portfolio and seeing what it throws out as a yield.
“Of course it’s not completely blind, you’re not going to pick 30 stocks that don’t pay a dividend, there’s a bit of common sense around this. Then we build the portfolio in line with our investment thesis,” Coombs said.
Rathbone Strategic Income Portfolio’s top five equity holdings are Roche, Legal & General, insurance company Sampo, Verizon Communications and Google.
“Google is an example of a holding that has no dividend yield. I get asked all the time why I’m overweight the US and underweight Europe because most of my competitors are the other way round,” the manager continued.
“In terms of P/E ratios and earnings, I could say ‘okay, Europe is cheaper and let’s forget what the growth outlook is’. So what I’m going to do is find the European equivalent of Google, Walt Disney, Apple and Visa etcetera. The answer is, you can’t.”
For Coombs, revenue growth and quality of management are more important factors than value, as the fund’s equity portfolio has been constructed with a long-term view in mind.
“I am never going to buy deep cyclicals or cheap stocks or recovery stocks in this fund. I’m not trying to beat an index every three months or a peer group with the equity portfolio, I’m targeting steady total returns, low volatility and a regular stream of income over the long term,” he added.
Over David Coomb’s time managing funds at Rathbones, he has returned an average of 50.75 per cent, outperforming his peer group composite by 10.96 percentage points.
Performance of manager vs composite
Source: FE Analytics
Rathbone Strategic Income Portfolio has an estimated ongoing charges figure of 0.72 per cent.
