This article is part of our Guide to Maximising Your Pension, helping investors build up the maximum possible pension pot – and turn it into the maximum possible retirement income.
Emma Wall: Hello, and welcome to the Morningstar series 'Ask the Expert.' I'm Emma Wall and I'm joined today by Morningstar's Dan Kemp.
Hello, Dan.
Dan Kemp: Hello.
Wall: So I have been speaking to a number of income investors, income professional investors over the last couple of months, fund managers who run multi-asset portfolios, fund managers who run bond portfolios, and they have been telling me that what is in their fund looks very different now than it did five years ago.
Kemp: Well, yes, I'd agree with that, and I think that’s one of the difficult things for investors, the end investor who are trying to generate an income from their portfolio, whether they're in retirement or they need an income for something else than just using funds with the income moniker means that you may get something very different in your portfolio from what you have had in the past. And people need to be very careful about what's inside their portfolio, how their fund manager is generating that income and really what risks they are taking.
Wall: Because income, of course, remains the number one goal for so many investors. It's not just for those in retirement, who are looking for an income, because we all know the accumulative effect of income units bleeds to growth. It's a great way to sort of maximize your growth as well. So we can't just say, you know what, that looks too risky for me, I'm not going to invest because income is so hard to come by.
Kemp: It is hard to come by, but also you have to be careful about how much you're paying for that income stream. And that in the current environment, where we see interest rates incredibly low, then equally the yield on risky assets is also quite low. And so that implies that the price is high and it may be that you are paying far too much for risky assets in order to get that yield and certainly you need to be careful about paying for yield from safe assets because that's very low and in many cases looks very expensive.
Wall: Because it is that dual factor, isn't it. We both had bond deals come down and that's across the board. That's not just with gilts. So we see high-yield bonds maybe not living up to their name as much as they should. And on the other hand, equities that produce a regular income, they have become known as bond proxies and they have become extremely expensive. So finding the right income at the right price no longer looks like it did five years ago.
Kemp: No that's right, and we've done quite a lot of analysis of income generating funds, both in the U.K. equity income sector and the overseas equity income categories. And what we've seen is that gradually the price you're paying for this income yield has been increasing over the last few years. So you're getting the same in terms of yield, but you're paying more for it; in effect, the cost of that yield is going up, which really means that the risk typically of that yield is going up. And I think one of the things that we are concerned about for income investors is that as they allow the risk in their portfolio to increase, but without the income increasing, then they've just made themselves more vulnerable to disappointments.
Wall: And so what should we do? Is it a case of accepting that this is the new norm?
Kemp: No, you should never accept things in investment. All the best investors will tell you that you look for the great opportunities. You don't just invest in whatever market conditions come along. And you make sure that you invest for the long term rather than just trying to grab the income that's available now.
And so I think investors need to be very clear about what they're holding or how much they're paying that income stream, how much their fund managers are paying that income stream, and be very selective in working at how you're going to put your capital to work. So we are not living in the same world we were six or seven years ago, where you could get a high yield from so many different types of investment. It's now much more selective.
And be very careful about the promises you're accepting, whether it's promises from high-yield bonds that may not be as creditworthy as you'd want them to be or promises of rising dividend yields for companies that may not be able to sustain this in the future. Be very careful about what you've in your portfolio.
Wall: Dan, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.
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