This contrasts to a typical dividend strategy, which focuses primarily on the consistency and absolute level of yield, an approach that can leave investors exposed to companies that have simply leveraged up to maintain high dividends – a mirage, in other words.
Among higher-yielding equities in the utility, telecommunications and European banking sectors, for example, there are less resilient opportunities. These are sectors where many companies are subject to regulatory restrictions on dividend payments, or have built up high levels of debt to prop up dividend payments despite low and volatile earnings reducing their resilience over the long-run.
The same approach of looking for sustainable cash flow generation to underpin yields applies to fixed income.
Currently, we see decent value in a number of bonds issued by developed market investment grade-rated borrowers, supported by strong balance sheets and resilient income, as well as some equivalent emerging market issuers.
Yield premia for the latter typically remain well in excess of comparable issuers in the developed markets. They entered the Covid-19 crisis in good health, with management that has prior experience of managing market volatility and leverage through economic difficulties.
Many BB-rated high-yield bonds, in contrast, have limited room for capital gains from any further fall in yields, but remain exposed to losses in the event of higher yields, downgrades or defaults.
While it may be an income desert out there, for us, the key to thriving is to build a diversified portfolio selecting attractively priced individual bonds and equities.
We look for securities that offer decent yields with income payments that are well covered by sustainable cash flows, rather than high-yielding securities that are less resilient than they might first seem. In short, we seek out the oases, not the mirages.
John Stopford is head of multi-asset income at Ninety One (formerly Investec Asset Management)
