BMO: The assets and sectors offering income opportunities

The days of the UK stock market dominating global dividends are long gone and income seekers are well advised to take a worldwide perspective when looking for yield. Our portfolio’s equity income exposure has become a lot more geographically diverse in the years since its launch in 2007 – a trend that reflects challenges at home but perhaps more importantly, the broadening income opportunity set.

Land(s) of the rising dividend

It was not that long ago that we introduced our first dedicated emerging markets equity income fund – an addition reflecting the fact that emerging markets are now more than just a growth play.

Of course, selectivity is key and managers need to carefully pick companies with the right cash flow profile and a progressive dividend policy. Dividends have certainly taken on greater importance in Japan – historically a country lacking the conditions and mind-set associated with sustainable equity income. That’s changed with Prime Minister Abe’s ‘three arrows’ and the greater emphasis being placed on corporate governance and shareholder-friendly practices.

Shifting from growth to income

Diversification of income is also key from a sectoral perspective. Historically, equity income portfolios have been heavily biased towards the likes of the utilities, telecoms and consumer staples sectors. The US stock market illustrates how the situation has changed. The tech sector was once a hunting ground for growth but is now home to cash rich giants capable of paying attractive yields.

But do these overseas opportunities make UK equity income a redundant concept? Thankfully not, but given the valuations among many income stalwart bond proxies and the lack of yield from the likes of the banks post the financial crisis, it is important to focus on opportunities that reflect a changing of the guard. That may mean selecting managers focused down the cap scale or selecting those seeking companies and/or sectors where dividend payments may be set for a renaissance or improvement.

Avoiding fixed thinking in fixed income

Fixed income is an important component of our income strategy. Here, again, a broader perspective and diversification stand to the fore of our thinking. Nowadays it is almost a given that you need to look beyond government bonds for income but when doing so it is critical that you know and understand the risks you are taking in return for higher yield.

In fact, our recent review of the fixed income space and our holdings served to underline the importance of this focus. Time and again, managers spoke to us about a deterioration in the quality of the covenants between issuer and bond holder. Failing to adequately understand and factor in a bond’s provisions can provide a painful lesson, which is why we are keen to ensure we favour managers that really get to grips with individual issues and the underlying assets in which they are investing. These assets can vary hugely – a supermarket operator may issue credit secured on its properties (real assets) while investors in an issue from a pub operator may simply be buying into an income stream driven by bar takings – a potential ‘glass half empty’ if the company begins to struggle.

Alternative locations

Property is a mainstay of many income portfolios but even in an asset type favoured for its reliable income delivery it can be beneficial to take a broader view. Our property exposure currently includes a fund investing in student accommodation that allows us to tap-into the imbalance in supply and demand for student housing in areas like London. We also invest in a holiday park operator that has proven to be a resilient performer in difficult times – performance that stood in marked contrast to more mainstream property options. Diversification of yield can also be enhanced by the numerous ‘income alternatives’ now available and with the right research capabilities it is possible to identify opportunities in areas such as asset lease financing, peer-to-peer lending and aircraft leasing.

Kelly Prior is investment manager at BMO Global Asset Management