Well-constructed multi-strategy portfolios can provide the results pension schemes need however volatile markets become. Investment strategies designed to deliver specific returns or levels of income in all but the most extreme market environments have proven attractive to a wide array of institutional investors in recent years. Their popularity lies in their ability to generate relatively stable returns that are uncorrelated to other asset prices. That in turn has made them an attractive option for pension schemes as they look to reduce deficits and fund the costs of hedging out their liabilities.
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The Aviva Investors Multi-Strategy (AIMS) Target Income Fund seeks to pay out steady, monthly distributions, while seeking to preserve investors’ capital, regardless of the investment climate. It seeks to achieve this goal by investing in a diverse range of sources of income: namely equities, government and corporate bonds and property, as well as by writing options. This article provides a brief introduction to the income-generating strategies in which the AIMS Target Income Fund invests. It also details some of the main advantages and disadvantages of each.
Income from Equity Dividends
Dividend yields remain attractive in relation to other income-generating assets and are also relatively high in relation to their own history. At 30 September 2015, the yield on the FTSE 100 Index stood at 4.30%, compared to an average of 3.36% since end-September 1998. By comparison the yield on the 10-year gilt stood at 1.78% on 30 September. What is more, company balance sheets appear to be in a healthy shape meaning that dividends look to be sustainable.
What is more, company balance sheets appear to be in a healthy shape, meaning that dividends look to be sustainable. Companies have been able to use their strong financial position in a variety of shareholder-friendly ways, such as dividend increases, special dividends and share buybacks. Importantly, the strength of the corporate sector means that dividends are sustainable.
In addition and in sharp contrast to many governments, corporates in many advanced economies have repaired their balance sheets since the global financial crisis. In the US, for example, corporate balance sheets in early 2015 were at their strongest since 2006 on a market-value weighted basis, according to a report from BNY Mellon Investment Management, published in March 2015. It estimated that total corporate debt had fallen to 25.1% of GDP from 34% at the time of the global financial crisis.
The risks involved in investing in equities are well known. Share prices can fluctuate wildly. Often this is for no better reason than a shift in investor sentiment. Ultimately however, the riskiness of shares is explained by the fact equity ranks at the bottom of a firm’s capital structure. In other words, in the event of insolvency, shareholders can only lay claim to a firm’s assets once debtholders and other parties to whom the company owes money have been paid in full. There is also a risk that companies may reduce or even cancel dividend payments, if they encounter difficulties through, for example, poor management, or a change in their industry or an economic downturn. In September 2015, for example, the mining giant Glencore announced it was suspending dividend payments reflecting the impact of a slump in commodities prices. However, we believe careful stock selection can mitigate these risks.
Income from Government Bonds
Government bond yields have fallen sharply in recent years, in many instances to the lowest level on record. That is largely down to the actions of central banks in the US, the UK, Europe and elsewhere. They have slashed interest rates and have been buying bonds in order to reduce yields and revive economic growth following the global financial crisis. Falling inflation, driven by a collapse in commodity prices, has pushed up bond prices further. There are concerns that the long bull market in bonds – yields in the US, for example, have trended lower since the early 1980s – is coming to an end. If bond prices do fall, then investors will inevitably suffer. Which begs the question: why have any exposure to government bonds at all?
The answer, we believe, is that firstly, when interest rates do eventually rise they will only do so extremely slowly and so we do not expect government bonds to sell off dramatically. Secondly, core government bonds still have an important role to play in protecting portfolios from market turbulence. This year, for example, has seen some equity markets fall sharply as a result of the Greek crisis and latterly, due to concern over slowing economic growth in China. On both of these occasions core government bond prices have rallied and helped to offset the impact of the drop in equities.
The AIMS Target Income Fund strives to build a balanced portfolio with a diverse range of sources of both income and returns that include ‘core’ and ‘emerging’ government bonds. To achieve this we use the skills of both our government bond and emerging-market debt specialists.
The AIMS Target Income Fund strives to build a balanced portfolio with a diverse range of sources of both income and returns that include ‘core’ and ‘emerging’ government bonds.
Income from Corporate Bonds
Yields on corporate bonds have fallen sharply in recent years, reflecting what has happened in government debt markets. However, they still look attractive relative to the yields on government debt.
On 21st August 2015, for example, the yield premium on global corporate debt over government bonds amounted to 2.4 percentage points, according to Bank of America Merrill Lynch indices. Moreover, it is possible to identify even more attractive issues in the high-yield and emerging-market sectors.
At the same time, default rates remain low. In August 2015, the ratings agency Moody’s was predicting that globally the default rate will end 2015 at 2.7%, well below the historical average of 4.5%.
However, following the global financial crisis many banks have shrunk their bond trading activities. As a result there are legitimate concerns that in the event of widespread selling banks will be less able to support liquidity than was once the case.
Income from Property
Real Estate Investment Trusts, or REITs, in which the AIMS Target Income Fund invests, provide easy and tax-efficient access to the income opportunities available from property. REITs also offer much greater liquidity than is available from investing directly in property.
However, REITs’ share prices move in tandem with broader equity markets during periods of stress as was highlighted during the August 2015 sell-off, sparked by concerns over China’s slowing economy. After several years of strong gains, the current real estate cycle is approaching maturity. And REITs are vulnerable to interest rate hikes just like other assets. But the fact interest rates are likely to rise only slowly suggests that the downside risk facing REITs is limited and that the income they provide will remain relatively attractive.
Income from Option Premia
Selling option premia allows investors to realise an additional return on, for example, their holdings of underlying equities. If we hold shares in a particular company we may look to generate extra income by selling ‘out-of-the-money call options’ on those shares. These call options give the purchaser of the option the right to buy the stock from us at a pre-determined price – the strike price – over a fixed period.
In the event the share price rises sufficiently the purchaser will exercise the option, at which point we will be required to deliver the shares to them and in return will receive the strike price.
By selling options with a strike price that is around five per cent above the current share price, and on shares we believe may struggle to rise by more than five per cent in the near term, we are looking to pocket the option premium in addition to any dividends that may become payable on the shares.
In the event the share price falls, the options expire worthless and the premium helps to offset the capital loss.
The main risk of this strategy is that we are potentially limiting the scope for capital gains in the event the share price rises above the combined value of the strike price plus the premium.
It is clear that there are pros and cons to investing in all of the above instruments. However, we believe that when combined intelligently, we can use these instruments to build a much more balanced income portfolio than would be the case if we relied on just one or two of them. Consequently, we are able to target consistent, sustainable income that meets the needs of today’s investors.
We are able to target consistent, sustainable income that meets the needs of today’s investors.
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at 31 October 2015. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Past performance is not a guide to the future.
The attention of investors is drawn to the ‘Risk Warnings’ contained in the Prospectus. Due to the fact the strategy will make significant use of financial derivatives, the following risk factor is particularly relevant:
Derivative risks: As a result of the high degree of leverage typically employed when trading financial derivatives, a relatively small price movement in the underlying asset may result in substantial losses to the fund’s assets.
The content of this document does not purport to be representational or provide warranties above and beyond those contained in the Prospectus and subscription documentation of the Fund. The Prospectus and the subscription document contain the full terms, conditions, representations and warranties in respect of the Fund. Nothing in this document shall be construed as forming any part of those terms, conditions, representations or warranties.
The distribution and offering of shares may be restricted by law in certain jurisdictions. This document should not be taken as a recommendation or offer by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation.
Portfolio holdings are subject to change at any time without notice and information about specific securities should not be construed as a recommendation to buy or sell any securities.
As the fund may invest outside of the UK or hold currencies other than sterling, any currency exchange rate movement may cause the value of an investment to fall as well as rise.
The Aviva Investors Multi-Strategy Target Income Fund is a sub-fund of the Aviva Investors Investment Funds ICVC umbrella. For further information please read the latest Key Investor Information Document and Supplementary Information Document. The Prospectus and the annual and interim reports are also available on request. Copies in English can be obtained from Aviva Investors UK Fund Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ or by contacting our Relationship Management Team on 0800 0154773 or email them on firstname.lastname@example.org You can also download copies from our website.
Investment into the Fund is provided by Aviva Investors UK Fund Services Limited, the Authorised Corporate Director. Registered in England No. 1973412. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119310. Registered address: St. Helen’s, 1 Undershaft, London EC3P 3DQ, an Aviva company. www.avivainvestors.com
Aviva Investors Global Services Limited is the Investment Manager to the Aviva Investors Multi Strategy Target Income Fund.
Issued by Aviva Investors Global Services Limited, the Investment Manager to the Fund registered in England No. 1151805. Registered Office: St. Helen’s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London EC3P 3DQ. Telephone Calls may be recorded for monitoring and training purposes.
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Compliance code: RA15/0650/31032016