Brexit, the expansion of personal credit and rising inflation are among several key areas of caution for income investors, according to Artemis Investment Management’s Jacob de Tusch-Lec.
Equities manager de Tusch-Lec, who runs the five FE Crown-rated Artemis Monthly Distribution fund along with bond specialist James Foster, said there several potential “obstructions” for investors in the market.
The manager said income investors need to proceed with caution as they navigate the current market environment.
“Financial assets in general, and those that produce a yield in particular, are no longer receiving unconditional support from central banks,” he explained.
“In the US, interest rates are creeping higher and quantitative easing is being unwound. Broader uncertainties, political and economic – and elevated valuations in many areas – also indicate that caution is prudent.”
Indeed, in the decade since the financial crisis began, valuations across asset classes have surged as central banks’ stimulative monetary policies have flooded markets with liquidity.
Performance of indices over 10yrs
Source: FE Analytics
De Tusch-Lec said his first area of concern surrounds Brexit and the fragile UK political environment, which could have a significant impact on the domestic economy.
“Unfortunately, Brexit is likely to dominate the news for the next five years,” said de Tusch-Lec. “The vagaries of every headline will move sterling and gilts, but perhaps as large a worry for markets would be the election of a Labour government.”
The manager said if the Conservative government were to fail and be replaced by a Jeremy Corbyn-led Labour one, expenditure would increase “significantly” and put more pressure on gilts.
However, he said the likelihood of a new government was low with the ruling party unlikely to call a general election despite infighting over Brexit.
“If, however, there are a number of by-elections, then the chance of a general election will increase,” he cautioned. “Not surprisingly investment decisions are being delayed and this is slowing growth.”
Additionally, the Artemis Monthly Distribution co-manager said low unemployment levels could trigger higher wage inflation and prompt the Bank of England to raise rates faster.
Indeed, de Tusch-Lec (pictured) said the threat of inflation and monetary tightening is another of its warning signs in 2018, noting the impact of stronger economic growth in the US, which could tempt the Federal Reserve to raise rates. 
“Across the globe, companies talk of capacity constraints and many claim they – at last – have some pricing power,” he said.
“All this will lead to higher inflation, which will lead to higher interest rates, and lower government bond prices.”
A bond issuance “bonanza” is another warning sign for the Artemis Monthly Distribution co-manager, who noted the large amount of issuance from issuers who would find it more difficult to raise cash in a normal environment.
“In a market flush with cash, any company or government – even the most poorly managed– can raise money,” he said.
“There has been a bonanza of issuance in the investment-grade bond market. Companies are taking advantage of strong demand and are taking on more debt.
“The issuance has been broad-based, coming across all sectors and with yields that we have often found very unattractive.”
This level of issuance at unattractive yields has underlined another of the manager’s concern: the low yields on offer in the high yield space.
“High yield bonds have been stellar performers this year,” he noted. “The fund has been a beneficiary of this strength. Having had over 50 per cent of the portfolio invested in this asset class has proven wise.
“Today, however, yields have fallen to unprecedented levels. In Europe, the high yield index now yields about the same as 10-year US treasuries. That is madness.”
Finally, de Tusch-Lec highlighted the rapid expansion of consumer credit, which he said could be impacted by higher inflation, a squeeze in real wages and a tougher regulatory environment.
As well as this, the manager highlighted the growth in car financing deals – known as personal contract purchases – and questioned whether adequate credit checks were in place.
“We question whether adequate credit checks are in place,” he said. “If not, the credit providers could be at risk because the FCA tends to favour the consumer.”
As such, de Tusch-Lec and Foster have taken several steps to protect the Artemis Monthly Distribution fund from risks in the market.
The pair have reduced exposure to the UK in the mixed asset fund to 23 per cent despite it remaining a compelling market for income investors.
“At present, however, the uncertainty arising from Brexit negotiations, inflation, rising interest rates and faltering consumer spending are conspiring to cloud the outlook for some UK companies,” de Tusch-Lec said.
Another way the managers have protected the fund is by taking a more negative view on US treasuries. They have taken a short position on the US government bonds as they anticipate further rate rises will push prices lower.
De Tusch-Lec said the pair had avoided almost all recent investment grade issuance as yields have been low and spreads are thin. However, they have been adding bank exposure in Europe at the expense of UK, highlighting improving sentiment.
In high yield bonds, the managers favour the US where they believe yields compensate them for risks unlike European assets, which do not represent good value. As such they have been increasing exposure to this area, although they warn that selection is important, avoiding companies with negative cashflows.
Finally, the managers have shifted its equity exposure away from “the highest quality, most expensive defensives and bond proxies” and added to cheaper cyclical value stocks.
“Companies such as General Motors benefit from stronger growth in the global economy, while our financial stocks such as Citigroup, Bank of America and Zions Bank are direct beneficiaries of rising rates as well as a stronger US and global economy,” he added.
The £739.3m Artemis Monthly Distribution fund invests in combination of global equities, bonds and cash and is located in the IA Mixed Investment 20-60% Shares sector.
Performance of fund vs sector over 3yrs
Source: FE Analytics
Over three years, the fund has delivered a total return of 29.84 per cent compared with a 14.36 per cent gain for its average peer.
Artemis Monthly Distribution has a yield of 4.17 per cent and has an ongoing charges figure (OCF) of 0.84 per cent.