Investors should look to shift their focus away from relying too heavily on capital growth of investments and instead actively seek a consistent income stream from equities within their portfolios, according to a global fund manager.
Talaria Asset Management co-chief investment officer Hugh Selby-Smith said historical data had demonstrated prioritising stable income returns was a strong strategy to navigate the current economic environment, which has been defined by high starting valuations for equities, elevated inflation and continual interest rate rises.
“Against such a backdrop, as EPS (earnings per share) declines, income rather than capital growth will become increasingly important for investors,” Selby-Smith noted.
“If we look back at historical returns for the S&P 500 since 1880, there have been three 10-year periods where income comprised all of investors’ returns, where capital values were negative for a decade. This was the case in the 1910s, 1930s and as recently as the 2000s.
“The ASX (Australian Securities Exchange) is no different. Between 2007 and 2020, point-to-point, all the returns generated by investors was from income. This is during a period that saw one of the largest resource booms, one of the largest housing booms and one of the longest stretches of low interest rates.”
He pointed out relying on the main sources of investment returns – dividends from stocks and interest income from cash or bonds – would likely expose investors to a certain degree of risk and volatility.
“As we saw during COVID, dividends can be cut and the risk of this increases as profits start to fall. Companies begin prioritising strong balance sheets, with dividends being the first thing cut,” he said.
“Overreliance on dividends can also lead investors to unwittingly develop a bias towards certain sectors, such as banks, resources and retail, particularly in Australia, which increases the risk in their portfolios.”
He acknowledged while keeping funds in cash or bonds has yielded consistent returns in recent times, the potential threat of reduced income during economic downturns presents a challenge for investors who depend on dividends and interest income. This risk arises from the possibility of central banks cutting interest rates to spur economic growth.
To that end, Selby-Smith suggested the most prudent approach for investors would be to ensure their portfolios include a source of income that diversifies risk and does not result in markedly higher volatility.
“Investors will need to review their portfolios carefully to assess where income will come from, while at the same time ensuring they are well diversified and not too reliant on unreliable factors such as dividend returns,” he said.
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