It could be time to reconsider the traditional, top-down approach to multi-asset investing. A detailed, bottom-up approach to income investing can bring greater certainty about outcomes and help investors set aside concerns about short-term volatility, as Francois de Bruin explains.
3 minute read
Perspective is everything.
The world is a small place. To astrologers, a mere speck of dust. The distance from the earth to the sun is roughly one hundred and fifty million kilometres. If we condensed that distance to the size of a sheet of paper the distance to the nearest star, Alpha Centauri, would be a stack of paper over seventy feet high. And if we were to attempt to cross our galaxy, the Milky Way, we would need a stack of paper five hundred kilometres high. And that’s just our galaxy. Based on what current technology allows us to see, scientists estimate there are over one hundred billion galaxies in our visible universe.
Multi-asset investors have traditionally looked at the world from sixty thousand feet, from the top down, and have tried to construct portfolios based on that perspective. But the danger, to paraphrase Abraham Maslow is “to a man with a hammer, everything looks like a nail”. The point is that not every problem can be solved in the same way, with the same tools. Different approaches and perspectives are often required.
With aggregate yields so low in absolute and relative terms many multi-asset income funds have been forced to pay lower yields or return capital as income in one form or another. But to investors who build income portfolios from the bottom-up, the world looks very different; the problem is not where to find attractive levels of yield but, which one of the multitude of opportunities to select. It means moving away from catch-all buckets, like the S&P, to the prospects of individual companies and business drivers that constitute the market. And then having the discipline to not simply chase high yield for income’s sake, but instead consider the long-term total return and sustainability prospects of each security.
The same applies to risks, and how we view them. Every investment decision involves taking a view on prospective risks. But for anyone seeking to get a handle on risk, there are a fair few challenges. Who knows what might come from the threats being made between major trading nations, the political standoff in the Gulf or more quantitative easing (QE) in the euro zone? And what does that mean for anyone looking to invest to fund their retirement, which could last years or decades?
Again, one option is to hunker-down and focus on what you can control. That still means looking for the best assets across the globe, and ones with the potential to generate sustainable income that grows faster than inflation. Furthermore, if the cumulative savings pot can grow to the point where the natural income being generated is ‘enough’ to satisfy an investor’s needs, there is the advantage of never being forced to sell assets at inopportune times. There should be no need to fear falling markets.
By looking at things from the bottom up each individual asset can be evaluated on its own diversification merits. And deciphering the correlation relationships at an individual asset level allows diversification to become a vital source of risk management. For example, the income outlook for those carefully positioned in data warehousing or last mile logistics is clearly different to those left holding unexciting retail locations with declining footfall.
Further dividing income sources into asset class categories is also useful. For example, a global multi-asset income portfolio might include developed market equities with low starting yield but an encouraging dividend growth outlook. Their accruing dividends can form a useful growth engine. They might be blended with higher yielding emerging market debt, much of which is now investment grade, along with Real Estate Investment Trusts, where future income distributions may also grow.
Sustainability: The devil is in the detail
Brick-by-brick analysis is resource intensive. Personal contact with senior decision-makers, engagement on sustainability – these all take time. But the advantage is that you can gain a deep understanding of each asset’s impact on the planet and its ability to generate cash.
And while any approach based on ‘sustainability’ can be contested, as methodologies vary and its nature is subjective, adopting a dual approach of exclusion and inclusion can help bridge the gap. Excluding vulnerable sectors (like tobacco and coal miners) and including assets judged on positive metrics and criteria.
Combining assets intelligently can create synergies. Intrinsically robust portfolios are built when the sum of the granular parts become more desirable than the individual components. Specifically, the overall yield can be higher than a traditional multi-asset income strategy and the propensity for income growth should be greater. If you imagine the investment universe as 25,000 stars, even after screening out for sustainability reasons (both ethical and returns) you are still left with a very large investment universe from which to pick high yielding and quality opportunities. Direct ESG engagement should also improve sustainability over time too.
Ultimately, a bottom-up approach should allow investors to set worries about short-term price volatility aside. After all, these movements are likely to be quite short-lived. Instead, focus on the detail, on getting to know exactly what is going to drive the income engine – and how that can generate a healthy income flow that grows, year after year.