Income generation for the last decade had already been challenging with the persistently low interest rates before the crisis, but because dividends for many of the highest dividend-paying companies have been cut, the challenge has intensified.
The pandemic has caused many of the biggest dividend paying companies, who previously used the low interest rate environment to fuel share buybacks and high dividend payments, to put a hold on such practices.
As such, investors now face a further continuation of a very low yield environment, this time without some of the largest dividend paying equities, which may force some to look for yield elsewhere to meet their desired levels of income.
In this environment, Shoqat Bunglawala, head of global portfolio solutions EMEA and Asia Pacific at Goldman Sachs Asset Management, said many of his clients are now looking further afield and adopting a more diversified approach in their search for income as a result of the crisis.
He said: “There’s a critical element of not stretching for yield but going and gaining exposure to weaker companies.
“We think that is susceptible to risks as well particularly given there’s still uncertainty and that we might face an uneven recovery.”
His portfolios are biased more towards the US, “where there is a better balance of sectors that are a bit more resilient”.
He explained: “Our view leads us to retaining an element of diversification and keeping a bias towards the US and focusing on high quality business with robust balance sheets that are more likely able to navigate through any further liquidity challenges and adapt business models to sustain revenues.”
As earnings season begins to kick off in the US, the impact of the coronavirus pandemic on earnings of many of these companies will be made clear.
Bunglawala said that as part of his income strategy, he is about 45 per cent exposed to equities, of which 27 per cent is invested in the US and 18 per cent in international stocks. He has about 10 per cent in US Treasuries, and the remainder is a mix of investment grade, emerging markets, and high yield debt.
He also revealed that he has been writing call options on equities which he said has also been a valuable contribution to their income.
“Given the element of uncertainty equity markets face, while we’ve seen the best quarter in years, we’re still expecting further volatility,” he said. “Exchanging some of that future upside for certainty now through writing call options and hedging some of that exposure has been a valuable contributor.”
Performance of fund over five years
Source: FE Analytics
The $85.4m Goldman Sachs Global Multi Asset Income Portfolio, which he oversees, has 25.93 per cent total return over five years, compared to the sector’s 19.76 per cent return. It has an ongoing charges figure (OCF) of 0.9 per cent.
Despite the gloom surrounding dividend-paying companies, Matthew Roberts who runs the £36.6m Fulcrum Diversified Liquid Alternatives fund, provided some reasons to be optimistic in the event of any future market dislocation.
“Whenever you get a big market dislocation, some things get caught up in a ‘baby in bathwater’ effect,” he said. “There can be some really interesting microgranular opportunities that can come out of these sorts of periods.”
He said for income-seeking investors, certain equities can be a good way to get exposure to clean energy, such as pure-play clean energy companies, utility companies accelerating the electrification of grid infrastructure for things like electric vehicles, or agricultural technology which relates to the way we feed ourselves as a population.
Another area the manager highlighted was liquid credit, which he said had a number of distortions as a result of Covid-19, pointing to Asian convertible bonds in particular.
He described them as an “interesting mechanism to gain exposure to China’s growth story in a reasonably inefficient asset class, perhaps slightly under the radar as well”.
While a number of hedge funds are closing as a result of heavy losses incurred after the March sell-off, he said certain strategies were alternative sources of income for some investors.
“I think there are some greater opportunities for real alpha-seeking liquid hedge fund managers on the long and short side. It’s an interesting time to gain exposure to those strategies as well,” he said.
Roberts said the struggle for income seeking managers has largely been a consequence of the previous decade of accommodative monetary policy, but he said it has been made worse with the Covid-19 shock.
“When there’s additional money in the system it needs to find home, and when people make decisions about where to put it, they are trying to figure out what assets they prefer, and they make a comparison,” he said.
“Perhaps it’s not surprising that they go to equities when you get offered a bond yield of close to zero or negative in some countries.
“We know a lot of money has flowed to equities and using traditional valuation metrics, they look expensive. But does it lead to a situation where the central authorities are able to inflate the economy out of the current situation or does it lead to a longer-term deflationary spiral?”
Nevertheless, he said the key to navigate the crisis is to be selective and identify themes that are robust and resilient through recessionary periods, suggesting that active managers could do better.
He said the mega trends that existed before the pandemic –like demographics, the environment, technological change, emerging market development – have been brought into sharper focus: “they are happening faster now because of this pandemic”.
As a result, he said he has now seen a real desire to get exposure to some of these areas.
Whilst he is currently neutrally positioned, selectivity is important and he is skewed towards active management and managers who can identify companies that can pay back their debts.
He has a slight preference for active managers who are good at diversifying “due to the major upward move in equity markets and tightening in credit spreads coupled with the view that there’s a lot of dispersion and inefficiency in the market”.
Performance of fund since launch
Source: FE Analytics
The Fulcrum Diversified Liquid Alternatives Fund has delivered a 1.06 per cent loss since launch in April 2018. It has ongoing charges figure (OCF) of 1.25 per cent.