The big challenge will be not paying too much for yield.
The prolonged days of ultra-low interest rates may well be numbered but the ever-intensifying hunt for income is showing no signs of loosening its grip in 2015.
But one of the major challenge for investors next year will be avoiding overpaying for income. This is especially true given that many yielding assets look fully priced, if not expensive, as a result of interest rates having been stuck in the doldrums for the past five and a half years. Combine this with the expectation monetary policy is set to tighten and the outlook for income assets looks somewhat mixed.
Chase de Vere head of communications Patrick Connolly says: “Income investors face challenging times in 2015. Equities are particularly vulnerable if we do not see sufficient earnings growth, while fixed interest will struggle in a rising interest rate environment.”
For yield seekers UK Equity Income funds were a dominant fixture of 2014, especially following the launch of Neil Woodford’s solo venture, the Woodford Equity Income fund, in June. Going into 2015, it is widely predicted that investors will continue to look to dividend paying firms to boost their coffers.
While the consensus opinion has UK equities down as fully valued, Axa Wealth head of investing Adrian Lowcock believes the potential for capital and income growth remains.
“Yields of many companies are still attractive,” he says.
Whitechurch Securities managing director Gavin Haynes forecasts equities will provide some of the best income opportunities next year. However, he cautions that investors will need to look beyond the blue-chips and the UK to reap the best rewards.
Haynes, who is a fan the Miton UK Multi-cap Income fund, says: “The bias of the FTSE 100 towards energy and mining provides concerns over prospects for dividend growth following the slump in commodity prices.
“UK equity income funds, which are prepared to have a material exposure to mid and smaller companies, could return to favour.”
He also recommends investors branch out and take a more global approach. Artemis Global Income and Newton Global Higher Income are core holdings within the Whitechurch portfolio, he adds.
Despite the concerns circling bond markets, the returns generated from fixed interest during 2014 surprised on the upside. But the continued strength of bonds has seen yields drop and given a rise in base rates will cause prices to fall, for cautious investors the asset class is looking ever-more risky.
Surveying the present backdrop, Fidelity Strategic Bond fund manager Ian Spreadbury is clear where the opportunities lie.
“At current valuations, high-quality corporate bonds still offer a decent yield pick up over government bonds, compensating for default risk and illiquidity, as well as providing investors with a hedge against equities,” he says.
Haynes, however, believes the asset class looks unappealing.
“A 2 per cent yield on 10-year gilts will only appeal if you believe the domestic economic outlook in 2015 is going to be particularly gloomy,” he says. Despite the uncertainty, Haynes expects opportunities will present themselves. Flexibility will be key and as such he tips malleable plays including the Jupiter Strategic and Twenty Four Dynamic Bond funds.
Looking to a more niche proposition, Henderson Global Investors multi-asset manager James be Bunsen backs specialist operator Real Estate Credit Investments, a closed-ended portfolio which invests in debt secured by commercial or residential properties in Western Europe and the UK. The fund manager anticipates it can “generate double-digit total returns next year, supported by a healthy dividend”.
One notable trend in 2014 was the rebound in popularity of property funds. With capital values on the rise and yields of circa 3 per cent plus on offer, bricks and mortar acted in many cases as a bond proxy and investors in their droves piled into the sector. In fact, throughout 2014 to the end of October, IMA listed property funds enjoyed a combined inflow of £2.9bn – more than was invested into the sector in 2011, 2012 and 2013 combined.
Looking ahead, the base case for property appears to remain sound given it is being bolstered by improving economic growth and the general hunt for yield, while loose monetary policy adds another layer of support.
Lowcock says: “Sentiment remains positive but perhaps softening – property managers are expecting returns to level out for 2015 although a total return of 10 per cent is still reasonable.” Haynes too is optimistic that UK commercial property can continue to reward investors next year and his favoured picks include the Threadneedle UK Property and Henderson UK Property funds.
For the more intrepid investor De Bunsen highlights the renewable energy sector. He cites in particular the Renewable Energy Investment Group, an investment trust, which has both onshore wind farms and solar parks.
He says: “Investment trusts with fully operational wind and solar assets offer investors a secure dividend, underpinned by long-term government subsidies, and revenues that are linked to inflation, with the potential for some net asset value growth.
“These defensive assets are growing increasingly popular with investors due to their attractive 5 to 6 per cent dividend yields but do not currently trade on such rich premiums as social infrastructure peers like HICL or 3i Infrastructure.”
Lowcock notes continued low interest rates, coupled with a strong demand from governments for projects, creates a supportive backdrop for infrastructure.
He says: “When looking at free cashflow or yield they look fair value, despite the pricey premiums characterising infrastructure vehicles. In the current environment a stable capital base and decent income yield is attractive.”
Haynes also believes property has a role as an income diversifier. He says: “The sector offers stable income flows, although valuations in some areas have become stretched in the search for income. However, I believe Lazard’s Global Listed Infrastructure fund is well placed.”