Investors should be prepared to look beyond traditional income asset classes as the changeable market conditions continue to pose challenges, according to Invesco Perpetual manager Sebastian Mackay. 
Multi-asset specialist Mackay (pictured) said since the launch of the Invesco Perpetual Global Targeted Income fund towards the end of 2016 markets have witnessed several significant changes to the post-global financial crisis status quo.
The manager joined Invesco Perpetual from Standard Life Investments in 2016 where he was part of the multi-asset team responsible for managing the successful Standard Life Investments Global Absolute Return Strategies and Standard Life Investments Global Absolute Return Bond Strategies funds.
The fund was launched targeting an income of 3.5 per cent above three-month Libor, equivalent to the yield on UK equity but also preserving capital after fees.
As such, the strategy invests in 20-30 investment ideas across a range of asset classes but with a key focus on volatility.
MacKay said: “A key attribute of the fund is that not every idea is in there for income generation: about a third of the ideas are their purely for capital preservation purposes and we need to have that flexibility.
“We’re not just chasing the highest-yielding bond markets or highest dividend equity markets. We can generate income from a lot of different sources, we don’t need to take on more risk by going to the highest yielding market.”
However, the market conditions present at the launch of the fund towards the end of 2016 has changed over the past 18 months or so.
He said: “The first period was fairly marked by very strong global growth, strong global trade, the bull market going up saw global equity returns of around 20 per cent in 2017.
“In that environment the things that worked best in the fund were those that were correlated to global equities, long equity positions, long emerging market debt, long credit.”
Now, the return of volatility to markets in 2018 has lent greater weight to the Invesco team’s diversified approach to income investing and capital preservation focus.
Indeed, the CBOE SPX Volatility VIX index – the so-called ‘fear gauge’ measuring 30-day expected volatility of the US stock market – spiked at the start of the year and has remained elevated after a relatively benign 2017.
Mackay said: “We think a more volatile environment is more likely in the coming years because we’re at the stage of the cycle where central banks haven’t been very accommodative and that has led to volatility across most asset classes.
Performance of index YTD
Source: FE Analytics
“We’re looking for volatility to be higher and that is something we can benefit from. It may upset some of the traditional long-equity positions but we’ll get benefits from things [in the portfolio] like equity volatility.”
Mackay said the changing market conditions have allowed the team to demonstrate the level of flexibility that they have to stand by positions in asset classes and employ ideas that might not necessarily play out immediately and justified some of the capital preservation themes in the portfolio.
“There may be very brief periods where 100 per cent of all trades are working at the same time but there are always going to be some that are working and some that are not because we have a diversified portfolio,” the Invesco manager explained.
“It does support the idea that you need to be more flexible in the way that you generate income don’t just keep the parts of any particular market with the highest income you can earn income from,” said Mackay. “Strategies like currency for example rather than just high yield bonds or dividend equity markets.
“We also have the flexibility to have ideas that are capital preservation only, which is quite important in this type of market.”
This flexibility to look at other asset classes has also opened up opportunities that were previously overlooked by income investors.
“One of the key features of this market is that – for the first time in a long time – cash is an attractive investment,” he said. “In the US you can get roughly 3 per cent income just by holding cash.
“It reintroduces a new asset class as yields move higher and it’s fair to say that some people think about an income fund a being akin to a bond fund but one of the key features of the multi asset fund is we don’t run systematically high interest rate risk.”
However, as central banks like the Federal Reserve have embarked on rate-hiking regimes, the manager has begun to add greater interest rate risk.
“Interest rate duration of the fund is under two years,” said Mackay. “It’s been a lot shorter than a typical bond fund which might be 7-10 years. As interest rates have risen we’ve started to find opportunities in that market.”
Yet, rate hikes are one of the biggest challenges for the team in the months ahead as the global economic outlook remains uncertain.
“The difficult thing is policy rates are rising but potential returns on assets aren’t rising commensurately,” he explained.
“If, for example, we have an inflation shock or central banks decide there is far too much financial risk-taking going on in markets and need to cool things and lower interest rates, bond yields, dividends and all kinds of returns could move off at a tangent. That would be a challenge for any investor.”
Mackay co-manages the fund alongside Gwilym Satchell, Richard Batty and more recently Georgina Taylor.
Since launch at the end of 2016, the fund has delivered a 3.88 per cent total return compared with a gain of 3.69 per cent for the average fund from the IA Targeted Absolute Return sector. It should be noted however that the sector is home to a range of different strategies.
Performance of fund vs sector since launch
Source: FE Analytics
The fund has ongoing charges of 0.87 per cent and a yield of 3.58 per cent.