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Income hunt: innovative investors turn to unconventional sources

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Income hunt: innovative investors turn to unconventional sources

At a time when many traditional sources of yield are failing to deliver above-inflation returns, investors face the dilemma of where to find alternative sources of income.

The relative unattractiveness of cash and Western government bonds is leading more and more investors to diversify at least part of their portfolios into more unconventional areas.

One popular income play is infrastructure, which can offer attractive yields for investors willing to pay a hefty premium.

Rob Jones, alternative funds analyst at Liberum Capital, says: ‘The attractiveness of the listed infrastructure funds, such as HICL InfrastructureGCP and John Laing Infrastructure, has been a well-documented trade.’

The sector is now trading on a 12% premium as a result.

But Jones adds that UK property trusts, which invest in diversified portfolios of secondary assets across the office, industrial and retail sectors, have until recently been overlooked by many investors. 

‘One fund that particularly catches our eye is Picton Property Income,’ he says. ‘It offers a fully covered 5% yield, trades on a single-digit premium to NAV (net asset value) and has delivered strong capital growth of late, with scope for double-digit NAV returns as the recovery takes hold.’

Green energy funds

Rob Harley, senior research analyst at Bestinvest, says investors are increasingly being tempted into alternative assets due to the lack of opportunities in what he would call the ‘core market’ such as sovereign bonds, for example.

He is also looking at alternative funds listed on the London Stock Exchange. Green energy-based funds, such as Greencoat UK Wind, offers a tempting yield at 5.85%.

Aircraft leasing funds such as Doric and DP Aircraft, are also on the radar. Payouts of up to 9% are possible with these vehicles, although investors should bear in mind they will be lower down the credit structure.

But Harley cautions that ‘with higher income usually comes higher risks’. So having a significant exposure to high yielding niche sectors could mean volatility if the market turns.

Meanwhile, Citywire A-rated manager James Vokins, who works across Aviva’s fixed income fund range, has noticed a surge in demand for tier two ‘cocos’, or contingent convertible debt instruments. Issued by banks, these securities give investors a coupon, like a bond, but can be converted into equity by the issuer.

‘They are very much in the limelight. There is a lack of alternatives yielding anything near as interesting as this,’ says Vokins.

Some order books for banks issuing cocos are 10 times oversubscribed, he adds, with demand coming from all types of investors.

‘There is strong demand from traditional long-only fixed income investors, hedge funds and even equity investors.’

The Aviva team are not keen on the original tier one cocos, as they say that in spite of an attractive yield they believe there is a weak structure. But the newer tier two cocos ‘compensate investors a lot more’, Vokins says.

The Aviva Monthly Income Plus fund has backed cocos issued by Credit Agricole, which yield around 5%.

Russell Waite, CIO at Affinity Wealth, also has global convertibles on his radar.

‘We are looking at convertible bonds as a unique asset class, as they “straddle” both equities and bonds. Investors can enjoy a stable income via the coupon element of the bond, but also participate in the potential equity upside created by the optionality of the conversion terms. With growing uncertainty around the future direction of fixed income and equity markets convertibles effectively offer an “each way” bet, which has a lot of attractions,’ Waite said.

In his view, talented managers and alpha generators operate in this space. The team favours RWC, Jupiter and Polar Capital’s strategies.

Diversify geographically

Elsewhere, investors not comfortable investing in alternative assets could diversify their portfolio geographically, by investing in an area where negative sentiment is priced in, or a region that is not traditionally looked to for income.

Talib Sheikh, (pictured) manager of the JPMorgan Multi-Asset Income fund, thinks the key for investors looking to boost income is global diversification, which has brought him to peripheral Europe.

‘Having a global reach and thinking innovatively is important, especially when you look at what traditional assets are giving you,’ he says.

Last year, the fund upped its exposure to European peripheral debt in Italy and Spain, to create a portfolio of bonds yielding 4-4.5%, capitalising on negative perceptions.

‘The reality is if there is negative news flow in Europe, the valuations won’t be there, so you get paid for taking that risk,’ he said.

As the outlook for the troubled eurozone has improved in the last few months, Sheikh has been compelled to switch out of peripheral securities and into European equity, which is giving him a yield of around 5%.

Whether investors choose to diversify by geography or asset class, it is clear they are going to have to work harder and be more flexible in order to secure significant levels of income in their portfolios.

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James Vokins
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