Leader: The risky pursuit of high-yield income

FS Adam Lewis 160 byline

The good old hunt for income. It has been a perennial investment theme in the past several years and with good reason too. Interest rates globally remain at historic lows, while the yields available from government bonds, both at home and abroad, remain miserable.

However while much of the discussion in the past has been on the ever widening search for income in such a low interest rate environment, little has been written on the implications of this hunt.

This week’s cover story by Tomas Hirst (see page 12) notes despite the high price of safety, bond assets continue to be mopped up by yield hungry investors as soon as they hit the market. However the problem is that those hunting for income above inflation are being pushed further and further up the risk spectrum.

The danger with this so-called “reach for yield” note a host of commentators is that it poses a systemic risk of a misallocation of investors’ capital. That is, the desire for income is so great that money is being ploughed into high-yielding bond instruments or companies with precarious finances, that it could increase the vulnerability of economies to sudden shock when interest rates eventually start to rise.

Indeed one report argues the hunt for yield was believed to be one of the core factors contributing to the buildup of credit that preceded the financial crisis. As such it is perhaps no great surprise that in this environment equities may seem more appealing, with dividend paying stocks, particularly the blue chips, vying strongly for investor’s attention.

The UK Equity Income sector has always been a firm favourite among UK retail investors, while they also have the choice of an increasing number of American, Asian, European and even emerging market equity income mandates. Indeed according to IMA statistics equity fund sales have eclipsed bonds over the past two quarters as equity markets appear less stretched than investment grade and high-quality government debt.

However, as Hirst warns, as valuations of equities creep up so the alarm bells should start ringing. But what to do as a fund manager where if you stay on the sidelines you are getting near zero returns on cash? Will it be a pressure too great to bear make managers go against their better instinct?