Psigma sets out ways to generate income in these ‘incredible’ conditions

17th June 2013

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Psigma’s chief investment officer Tom Becket has set out how he believes the fund will generate income in what some are calling a yield free world without concentrating risk.

In a note issued today, Becket points out that UK interest rates are at a 200 year low and there have been 510 interest rate cuts by the world’s central banks since 2008/2009 with recent “slashers” including a real variety of countries and regions, such as Europe, Australia and Korea.

The most lasting impact of the central bankers’ Zero Interest Rate Policy has been a significant re-pricing of any investment with a yield.

“Investors and savers are desperate for income and the clamour for yield has driven many assets to unrealistically high valuations. This has meant that we have had to be dynamic with our asset allocations over the last few years and a key reason why we employ a “forward looking” investment process,” he says.

Becket notes that quantitative easing  has had an incredible impact on government bond yield “Ten year yields having been well below 2% for much of the last two years in Germany, Switzerland, US, Japan and the UK, for the most part offering investors sub-inflation returns or “negative real yields”, rendering them un-investable to us at least. Some are debating when the ultra-easy monetary policy might end, but we have learnt in recent years that central bankers are likely to try and print too much new money, rather than too little, and this pressure upon income seems set to stay with us for some time to come.”

Investors have therefore been pushed out along the “risk curve” in search of attractive yields, starting with government bonds, through all types of corporate credit and now in to real estate and equities. It has set this out in the following table.

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The Suppression of Risk Premia (Source: Psigma IM)

The conditions also mean many traditional corporate credit markets are also unattractive.

“Yields are at the lowest ever levels, as evidenced by the US High Yield Bond Index yield falling below 5% in May for the first time in its history. Such investments now present very high interest rate risk. In short, they will suffer when interest rates finally start to rise, impacting capital values. We have tried to shield our clients’ assets from the threat of rising rates by only owning short duration assets, where we can achieve yields of 4-5% with little interest rate risk as the bonds mature in under three years. Current favoured investments include the AXA Short Duration High Yield and AXA Emerging Market Bond funds.”

The firm has also created its own mandates. The note adds: “One such investment is the TwentyFour Focus Bond fund that we structured in early 2012. The unique nature of this fund is that all of the bonds that the fund invests in will redeem within three to four years. This “finite” life of the fund does, we believe, considerably reduce “duration risk” and offers a reasonable degree of protection against the possibility of rising interest rates, whilst providing an income stream of c.7% per annum. We also recently seeded a small US corporate debt fund, Airlie Select US High Yield, which invests in bonds issued by smaller companies and generates a yield in excess of 9%.”

The fund has also invested in holdings that have floating rate coupons.

“Key holdings within our portfolios include the Neuberger Berman Floating Rate Investment Trust, which has a yield of 5.5% and the income is linked to interest rates, which will also go up when rates eventually rise. A similar investment would be the TwentyFour Asset Backed Income fund, which invests in very high quality European asset-backed securities and pays an income in excess of 8%, again with floating rate coupons. This fund was specifically created for our clients earlier this year and we believe that this is one of the most attractive opportunities currently available across global financial markets.”

Becket points out that in terms of equities a lot of money has been going into defensive stocks but this theme may be getting a little tired.

“The new money coming in to equity markets is mostly going to high quality “defensive” businesses, with strong balance sheets and healthy dividend yields. This has led to a rare phenomenon of “boring but worthy” sectors such as utilities, healthcare and consumer staples leading the market higher in the recent rally. We have had a high weighting to such investments over the last few years through our “defensive delights” theme, but we believe that now is the time to start reducing expensive investments such as these and to focus on better value, long term opportunities. We don’t believe that defensive equities will necessarily be bad performers in the years ahead, but we believe that their best days are behind them”.

The note then considers the following four investment opportunities.

Better Value Equity Income Strategies Exist

Reassuringly it is still possible in equity markets to buy globally diversified and balanced funds, such as our top pick Lazard Global Equity Income, with yields close to 5%. This fund is a key indicator of the value that still exists in equities, as the fund owns a collection of companies whose combined valuation is a moderate 11x earnings, with 10% annual earnings growth forecast by the manager. Such valuations are hardly expensive in our opinion. In the UK it is possible to buy traditional equity income funds with a covered call strategy, where the managers use simple derivatives to enhance their investors’ yield, such as Schroder Income Maximiser and RWC Enhanced Income, a recent Psigma selection, with yields of around 7%.

Emerging Income in Emerging Markets

It is not just in the developed world that investors can find companies with attractive dividend yields. If one wants to look to the exciting Asian markets there are funds, such as Prusik Asian Equity Income and Schroder Asian Income, where you can comfortably achieve yields in excess of 4% from a diversified selection of potentially high growth opportunities. In short, our income stream does not need to be solely secured from the mature world, and is globally diversified.

Looking to Alternative Markets for Income  

If investors want to look to more niche investment opportunities there are new markets such as reinsurance bonds (Catastrophe Bonds), where investors can effectively lend money to insurance companies insuring against extreme natural catastrophes. These bonds are typically only triggered against 1 in 100 year type events and it is still possible to buy a diversified portfolio, such as the GAM FCM Cat Bond fund, with a yield of 8%.

Benefitting from the New Environment

We have also recently made a purchase in infrastructure assets, through the addition of GCP Infrastructure, an investment trust focussing on staple and stable assets, such as hospitals and schools. We believe there is a great opportunity to make positive uncorrelated returns from this fund, as well as an attractive yield. Demand for infrastructure assets is currently extremely high, as the worlds’ investors struggle for income in this low yield environment. This fund is a good example of how we can find opportunities to exploit in changing markets. Here, as investors, we are replacing the banks who used to lend to this sector but who now need to restrict/ conserve capital and can only lend small amounts. In return for lending to such infrastructure trusts, you can receive an income of c8.5% to 9%, with some inflation protection on certain contracts.

The note concludes: “Clearly the above are not cash substitutes, but hopefully we have demonstrated that it is still possible to put together a diversified portfolio of income producing assets in this era of “financial repression” and low interest rates. We are doing this without investing in illiquid investments and avoiding expensive traps, such as commercial property funds.”

 

 

 

13 thoughts on “Psigma sets out ways to generate income in these ‘incredible’ conditions”

  1. dutch says:

    To be fair,UK politicians have been pretty adept at rewarding themselves for running up a debt.

    So,basically, here we have an example of what happens when you print a shedload of cash and then run trade and fiscal deficits into a mounting national debt.

    The only thing between the UK/Japan/Italy/Spain etc and the same outcome is arbitrary faith in their currencies.

    1. Anonymous says:

      Hi Dutch

      There is a type of economics lesson here. It was often thought before the credit crunch that QE would lead to a falling currency but in practice the results have been much more complex than that, partly I think because so many have tried it.

      However direct monetisation as tried by Ghana in the early part of this year has led to the type of currency free-fall expected…

  2. Pavlaki says:

    I cannot think of one successful African nation nor can I think of one where corruption is not endemic. Part of the problem is that most countries are made up of a number of different tribes who really don’t like each other and whichever is in power then they seak to reward members of their own tribe at the expense of others. The Yoruba, Hausa and Igbo in Nigeria are a classic example. This can end up in warfare as happened between the Tutsi and Hutu in Rawanda. In the tribal system the elder or leader is expected to look after his people and to do this they raid state coffers and accept (and pay) massive bribes. Not one leader has broken this stereotype. There were high hope for Mugabe when he first came to power but he ended up like all the others. Mugabe is/was a very bright and well educated man but still couldn’t break away from the tribal and crony system.

    Working in Africa can be a tribal minefield – as I found out! If you promote a member of a minor tribe over those in power (based on merit) you have a riot on your hands! One learns quickly who holds the reigns of power even at a very low level.

    Most of Africa could be incredibly wealthy but for this factor however I do not see it changing anytime soon. The Chinese have learnt to play the system and are buying the place up and cornering the natural resources. They are also playing a long game and buying up agricultural land as hey will use this to feed China in future at the expense of locals. They bribe and pay off tribal leaders and politicians now but I expect that in future they will be prepared to defend their acquisitions with force if necessary. Africa is selling its future.

    1. Anonymous says:

      Hi Pavlaki

      It all seems such a shame doesn’t it? From time to time I speak to athletes who have gone out to train in Kenya and the major subject of their conversation is the bribes that they have had to pay to do so.

      As your point out it leads to a very disorganised system. In the short term I fear this will hamper the fight against ebola and in the longer term the very organised Chinese will continue their march forwards.

  3. Anonymous says:

    Great column, Shaun, as usual. Does the Bank of Ghana really have a target rate of inflation of 10%, with no specified upper bound? What were they thinking? Surely it is just asking for the kind of surge in inflation you have chronicled. Even the National Bank of Serbia has a lower target rate than that and it does have an upper bound. Andrew Baldwin

    PS Yesterday was the 60th anniversary of the Miracle Mile race at the Commonwealth Games in Vancouver, the first race in history where two men had finishing times under four minutes. No visit to Vancouver is complete without seeing the oversize bronze statue there showing John Landy looking over his left shoulder as Roger Bannister passes him on the right on the final turn.

    1. Anonymous says:

      Hi Andrew

      I agree that the target below is rather defeatist.

      “The desired inflation target of below 10 percent is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI).”

      With inflation pushing to 15% we can see that it is currently an utter failure and with interest-rates at 19% it is crunching the economy. Looking at the overall regime since it started in 2002 then there was a brief period of success but since then 10% inflation has been a base rather than a target.

      Thanks for the athletics reminder as I am a big fan. The 4 minute mile was such a big deal and yet now the record is 3:43 extraordinary isn’t it?

  4. forbin says:

    Hello Shaun,

    much has been covered by other posters regards Ghana, not even North African countries are free of the evil of corruption .

    Lets not get started with the Arab spring in Libya – that’s doing so well

    Egypt? under military control

    Even South Africa is a one party state thats moribound from what I have heard from emigrants here.

    As for corruption here – well we’re more civilized about it

    As for the balance of trade – expect that to head south to 26billion eventually – as the oil and gas cannot over come their reserve depletion issue.

    Progrock is right – the UK is a basket case waiting to have a Black Swan event …… energy wise is the main suspect , but swans will come as they do.

    Still its the weekend , some beer and popcorn needed and sit back and watch the show …..

    Forbin

    1. Jim M. says:

      Any idea when the curtain goes down in this show, Forbin?

  5. mcgrathr20 says:

    Corruption in Africa is a problem, but not the main problem by far. Incompetence and lack of skills is a rousing first

    1. Anonymous says:

      Hi mcgrathr20

      In my opinion the three problems you list are interlinked. Indeed corruption and incompetence are regular bedfellows. The real issue is how one manages to change things for the better which so far has proved to be virtually impossible.

  6. Anonymous says:

    It seems to me the IMF advice should be pretty simply stop spending money from oil revenues that have yet to arrive. An slowdown the pay rises. The economy should self correct in a few years time. or may be I’m just oversimplifying things.

  7. Anonymous says:

    Hi ExpatInBG

    Ghana has plenty of natural resources such as gold, cocoa and now oil yet much of its population remains poor. Much more should be made of this as it should be a contradiction! As you point out there seems to be a prevalence of “sticky fingers” along the way.

  8. Anonymous says:

    I wonder if it sticky fingers or choosing the wrong priorities.
    It much easier to convince an electorate to vote for you back into office if you given them a 20% pay rise (a made up figure in this case) than say they should reelect you because you built a new port or built new roads to remote village or a new mine or set up a trust fund for the country to save the oil revenues for the future and give the country to full back on in hard times.

    Another problem is probably the lack of secondary jobs being created by oil and gold incomes as people prefer to import good rather than buy locally made and manufactured goods.

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