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Key takeaways
- Income funds are focused on assets that generate stable returns such as dividend stocks and certain types of bond, potentially alongside commodities and other alternative assets.
- They are designed to be managed in a disciplined way to provide regular income to investors, which can lead to a more measured and steady approach.
- Many income funds are diversified across asset classes to smooth out the effects of turbulent and uncertain market conditions.
The volatility seen in equity markets has shone a light on a concern that is top of mind for many investors. Geopolitical uncertainty, disruptions to the energy market, and concerns about high valuations have created a complex backdrop in which the prices of some stocks appear fragile.
In this environment, some investors are asking if it is time for a different and more pragmatic approach to portfolio construction. Income funds, which may be able to support an investor’s lifestyle by providing a regular income, have come into focus as a potentially useful tool to help investors meet their day-to-day needs while also navigating a volatile market environment.
Why income funds may be an attractive option now
For investors, income funds may offer several potential benefits in the current environment. Because of the requirement to provide regular income, these funds have to be managed in a disciplined way, which can lead to a more measured and steady approach. That is an attractive feature in a global economy where geopolitical uncertainty can upset economic flows, and where an enormous amount of investor capital is committed to new and fast-moving technology.
Then there is the interest rate environment to consider. The uncertain outlook can limit central banks’ ability to cut interest rates.
Higher interest rates are potentially challenging for holders of core bonds, such as US Treasuries; however, alternative fixed income instruments may be less affected. These include floating-rate notes, which have coupon payments that periodically reset up and down according to short-term interest rates.
Income funds may use these types of bonds, alongside others such as short-duration high yield bonds, for example, or convertibles, which are bonds that include the option to be converted into stocks. Convertibles can be seen as offering a kind of “built in” protection against falling stock prices.
Connected to the “steady and reliable” theme is the concept of diversification. The US stockmarket has enjoyed a lengthy bull run over the past decade and a half, during which time bonds have frequently performed poorly. But our research on “breaking the barbell” found that this period of equity outperformance versus bonds is unprecedented in the last 65 years. The only period that came close was the dot-com bubble in the late 1990s, which was followed by a substantial three-year stock market correction.
Getting the balance right between stocks and bonds is likely to be crucial to protect and build wealth in the coming years. In an actively managed, multi asset income fund, the fund manager has the ability to adjust the balance between stocks and bonds in response to market conditions, helping to manage risk and provide more stable returns.
Are income funds the right choice?
Income funds are not necessarily the right option for every investor. For those with aggressive return expectations, or a very long investment horizon, funds tilted towards risky assets such as growth stocks may be the appropriate choice.
But for investors with a preference for more stable returns without big swings in price, or who are using their funds to support their present lifestyle, income funds may well be a good fit. In today’s environment of volatile stock prices, “higher for longer” interest rates, and an unpredictable US administration, they might be more relevant than ever.