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Hugo Thompson, HSBC

Is multi asset the answer to income generation?


Hugo Thompson, Multi-Asset Investment Specialist, HSBC Asset Management writes that investing for income used to be the easiest game in town. 

Twenty years ago, when a 10Y UK Gilt had a 5 per cent yield, income investors could simply buy a domestic government bond, or a little investment grade credit, and the income would just come rolling in.  
Unfortunately, as interest rates have only moved in one direction for the past 30 years, fixed income investors have seen this stream of attractive cash flows dry up, leaving income hard to come by in the world of developed market government bonds.

As familiar as all of the above might be, readers will perhaps be less aware of what has happened to yields in equity markets – they have been relatively stable such that the difference in yields between equities and bonds – the so called ‘yield gap’ – has widened. 

And in addition to dividends, companies have been returning money to investors through share buy-backs. This means that the real opportunity for income generation now lies outside of government bonds. Should every income investor switch their portfolio into global equities? No. While fixed income yields might have evaporated over the past decade, the need for risk control has not. Instead, the solution is Multi Asset. Multi asset portfolios provide investors access to the attractive yield in equity markets and exposure to corporate bonds, and balance those risks with safer assets.

Additionally, multi asset portfolios have access to an expanded opportunity set, including asset classes with higher yields. These might be unloved areas of the market, like REITs, or asset classes which embed a complexity premium, for example, infrastructure. By including these asset classes in portfolios, multi asset investors are able to squeeze more yield out of their portfolios. Furthermore, there are some potential diversification benefits: if the correlation between these assets and more traditional holdings is low then income may even be maximised without a commensurate increase in overall risk. 

Portfolio yield can be further improved by using yield enhancing active equity strategies. The problem with such strategies, however, is that they often generate significant factor, sector or country biases. To overcome this challenge, we advocate the use of systematic income strategies which can precisely control these parameters ensuring that the optimal amount of active risk is taken in order to achieve the investment objective. 

Option writing strategies also allow multi asset investors to generate a further uplift in portfolio yield. Portfolio managers can write options on the stocks that they hold in their portfolio (‘covered calls’) and, in doing so, receive a premium which can then be paid out to supplement dividends. Setting the premium at the correct price to reflect the risks embedded in the agreement and an understanding of the expected return profile is, of course, key.

Additionally, global investors are able to use FX hedging to their advantage in order to generate income.  If a portfolio holds securities in a currency with a lower yield than the base or domestic currency, then selling down this FX exposure in exchange for the domestic exposure can generate yield, or ‘carry’, and bolster the portfolio income profile further.

In summary, for investors interested in income, government bonds alone are no longer fit for purpose, while the risk of equity may well be too high. HSBC’s Multi Asset Income funds solve this problem and more; providing access to the dividends from equity markets, income from the broad corporate bond market, risk-controlled yield pick-up from an expanded bond opportunity set, income enhancement through strategy selection, and additional carry from option and hedging strategies.

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