Where Can You Find Income Now?

Talib Sheikh: Good morning.

Wall: So I thought I'd start by saying equities versus bonds which is better in the current environment?

Sheikh: I think it has to be equities. They are assets which are cyclically exposed they'll typically do better than fixed income as the global economy starts to heal. I think there is a more specific point though in income oriented products, when we think about where yields have come post the financial crisis. They’ve come down to all time tights on spreads and also absolute levels. The actual opposite is true within the equity market. So when we look at dividend yields. In many cases, dividend yields have expanded and in some cases they are actually yielding higher levels than are available in the corporate bond market. We think that that’s attractive.

Wall: Having said that, you have reduced your equity position over the last six months, haven’t you?

Sheikh: No, the equities have gone up. So when I look at a high yield position around a year ago we had around 50% of the fund invested in high yield, spreads have come in, we still have a lot high yields that’s giving us an all in income of around 6%, 6.5%, but really we've redeployed that capital into the equity market harnessing those dividend yields and harnessing an asset where we think we can get some capital growth. Particularly as we do see signs that the global economy is starting to heal post the great financial crisis.

Wall: As well as having a multi-asset remit, you do have a global remit. Looking then what's happened in recent years in emerging markets and developed markets. Which do you favor and is that different for equities and for bonds, because in the bond market and emerging markets the bonds and equities are more closely correlated aren't they.

Sheikh: We've been pretty negative really on emerging markets. They've underperformed developed markets for around three years. We can make the case as valuation argument for holding them out. But we see few catalysts when we look at our exposures in the multi-asset income fund. We have a preference for developed markets over emerging markets. We think that there is value in developed markets. We also think that they have a positive tailwind of central banks keeping liquidity really abundant for the foreseeable future, and I am just not sure that that's the case in emerging markets. So when we look at allocations were relatively underweight.

I think there is also some interesting divergences, at the geographic level one area which we're becoming increasingly positive and have been increasing our allocations has been to the European equity market, able to harness a dividend yield around 5%. We saw the ECB starting to engage in unconventional monetary easing. We think that that’s something which is in-train, we think that is something which has very powerful effects on risk assets. So we've been increasing our exposure to European equities over the past few months and certainly when we look forward I think that’s a bet which we will reinforce underpinning those decent dividend yields are now underpinned by some pretty attractive valuations.

Wall: You mentioned the divergence within the developed market sector presumably you are talking about the U.S. after sort of five year rally and all-time highs continually topping one another. Do you think that market is fully valued, bearing in mind obviously you do have an income bias?

Sheikh: We have been taking capital out to the U.S. if we look at the broad index as a whole in the U.S. it probably looks slightly rich to its historic averages. It doesn’t really scare me though. I think you are getting above train growth in the U.S. you are getting much higher quality earnings and much higher quality GDP growth.

So I think that's worth paying for. But clearly in a fund that does have an income orientation as you say it's making all-time highs it's rallied pretty much in a straight line for the last four years. Some of the dividend yields have become a little bit more compressed. We want to keep the yield on the fund we are currently distributing around 4.5% to 5% that kind of level. So we really need to look for cheaper opportunities in Europe is somewhere which kind of stems out as really having perhaps a more attractive profile than the U.S. at the moment.

Wall: When you are looking at 4.5%, 5% income when interest rates across the developed world are so low, that is attractive. Presumably you don’t really have to look at alternatives than to boost that yield when you are getting such great offers from equities?

Sheikh: I think alternatives are important one of the things that end investors and ourselves as professional investors have to think about is where correlations are likely to change as we look forward. Over the last five years we've seen bonds and equities rally, together they've both risen in price really driven by abundant liquidity coming from central banks. I think liquidity stays ample in markets for the foreseeable future, but those correlations perhaps are not going to change. So when we think about alternatives we are looking for things that are cheaply valued. We are also looking for things that can diversify the portfolio.

So when we look at things like non-agency mortgages in the U.S. that gives a decent dividend yield they behave a little bit like a duration asset perhaps they can give us some diversification. Preference shares in the U.S. is another good example of really a non-core asset, very difficult for end investors to access on their own which gives a little bit of diversification away from just purely holding equities and just purely holding fixed income. I think that’s going to be important for the rest of this year and into next year that liquidity environment maybe just changes slightly.

Wall: Some of your multi-asset peers have favoured cash as a way to have that buffer of liquidity and also be ready for when opportunities do arise. So they are only one step out of the market. Do you have a cash allocation at the moment?

Sheikh: We don’t, I mean when we think about relative pricing across different asset classes I would argue that cash is the most expensive asset globally. Really that’s not surprising, because at the end of the day quantitative easing, ample liquidity from central banks is trying to force end investors up the risk spectrum. So holding cash becomes incredibly expensive, within our portfolios we hold the minimum amount that we possibly can.

We find that there are other asset classes which give us the same degree of liquidity, we can alter our asset allocation as we see opportunities arise. But in a portfolio where we are paying out 4.5% I can't hold cash at zero, it's just far too expensive. I'd much rather hold maybe some peripheral bonds in Europe they are liquid, they give us 3.5%; 3%, 3.5% it's about making sure that the portfolio works as hard as it possibly can. I think having a large cash allocation as a professional fund manager is somewhat lazy.

Wall: Talib, thank you very much.

Sheikh: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.