Why the current climate can benefit income assets

David Hambidge, investment director for pooled funds at Premier, explains why income is one of his top themes for 2012.

In spite of ongoing concerns over the eurozone debt crisis and fears that China’s slowdown could result in a hard landing for the world’s second largest economy, risk assets and particularly equities have made a solid start to the year.

Much of this is due to the fact shares have already discounted some of the macro issues facing the world while recent economic data out of the US has been more encouraging.

Slow growth

While predicting the short-term direction of share prices remains a mug’s game, it seems clear the developed world is going to have to endure slow growth and further deleveraging for several years while developing nations should continue to power ahead, albeit not in a straight line.

This will in turn mean that interest rates will likely stay lower for longer in Europe, Japan and the US while we will see some softening in rates in the emerging markets from their currently fairly high levels.

To us, equities remain relatively attractive and although we should expect earnings to come under pressure this year, this is largely reflected in current valuations.

One of the most bullish arguments for shares is how attractive valuations look compared with government bonds.

Taking the UK as an example, equities yield roughly 4%, nearly double that of ten-year gilts. We have some sympathy with this argument but would suggest that as a result of huge central bank intervention in the UK government bond market, it is gilts that are extraordinarily bad value rather than equities being a one-way bet.

However, the yield of the UK equity market is certainly attractive at current levels and we expect investors and companies to pay more attention to dividends in what will remain an income hungry world for a very long time.

Income focus

Indeed, income is very much one of our themes for 2012 and while equities may be relatively attractive, there will be many investors who will be permanently scarred by two savage bear markets in the last ten years and seemingly ever increasing levels of volatility.

Luckily there are plenty of other less volatile income-producing assets that look relatively attractive, including corporate bonds, many of which do not carry too much interest rate risk and should perform reasonably well in a low growth environment.

Other opportunities

Elsewhere, we have seen further issuance in the listed infrastructure space over the past few weeks and we are not surprised to be seeing such strong demand given the high government backed yields these vehicles offer coupled with relative stability of capital.

Although not on so many investors’ radar screens at the moment, UK commercial property produced a more than decent return last year even though there was little in the way of capital growth.