29 June 2020
With interest rates at record lows, many investors are being forced into assuming greater risk in their portfolios to generate acceptable levels of income. As an example, bank term deposits are currently yielding a meagre 1.7% pa compared to the 40 year average of over 6% pa. As a consequence, investors who rely on income as a primary source of return are being forced into making more risky investment decisions to sustain their lifestyles.
Typically, retirees comprise a large portion of this ‘yield dependent’ investor class which is a cause for concern because they are often at a stage where they should be decreasing the risk in their portfolios. There are well-documented reasons to support this such as sequencing risk, shorter investment horizons and liquidity risk to name a few. Hence, achieving the optimal mix between yield and risk in a balanced retirement portfolio has possibly never been more important.
The relationship that exists between yield and risk has been applied across a selection of major asset classes in the chart below. In the first instance, we define risk as price volatility, and secondly as the drawdown experienced during the recent market rout (ie 20 February to 23 March 2020). The relationship is consistent across both metrics.
Figure 1: How much capital volatility is embedded in your income?
Figure 2: How much capital drawdown risk is embedded in your income?
In the analysis above, the blue trendline plots the relationship between increased yield, and increased risk. Investments above the line represent more efficient income portfolios for the risk assumed and conversely those below the line less efficient. The returns on cash were used as an anchor point for both risk assumptions, so to make valid comparisons with a mostly ‘risk-free’ 1.7% income return on cash.
The conclusions are readily apparent, but it is worth elaborating on the details.
Dollar for dollar, within conventional asset classes it remains difficult to go past Australian equities in terms of yield generation for the risk assumed. Even with the high exposure to financials the yield is relatively more diversified than many other typical income sources that have a high factor concentration, plus it offers ample liquidity and includes the possibility of capital growth that is not included in the above analysis. IG Bonds and Hybrids may also play a role in terms of delivering diversified sources of ‘risk efficient’ income, however breadth, liquidity, and credit deterioration (especially for hybrids) could prevent inclusion in some portfolios.
For investors willing to venture past the more ‘conventional’ asset classes there is the Wheelhouse Global Equity Income Fund. In this case ‘less conventional’ does not mean ‘more risk’ but rather the exact opposite. The Wheelhouse approach delivers a materially beneficial yield for less risk when compared to conventional alternatives, with none of the liquidity, diversification, or factor dependent risks.
At Wheelhouse, we recognise that income is only as good as the security of the capital that is generating it. Our unique process is outcomes-focused, and seeks to deliver a real 7-8% income stream while assuming the lowest risk possible – typically around half the equity market’s risk.
Where are we different? The funds approach to income generation and capital protection is unique, and different to all conventional strategies.
With the Fund passing its three-year milestone this month, both the yield and the risk have proven consistent across a variety of market scenarios, as evidenced in the analysis above.
Yield vs risk – or as we call it, income and protection – that’s all we do.
Asset class proxies
Aust IG Bonds Solactive Australian Investment Grade Corporate Bond Select Index (SOLAUSIG).
Hybrids Solactive Australian Hybrid Securities Index (SOLAUDHG). .
Global Infrastructure FTSE Global Core Infrastructure 50/50 Net Total Return Index in AUD
AREITS ASX-300 AREIT Index
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