For income investors, ‘Tina’ raises more questions than answers

Some say ‘there is no alternative to equities’, but Andrew Pitts disagrees, suggesting funds, trusts and other diversifiers.

In the heat of summer, stock markets tend to doze off, and until last week that was indeed the case, despite a global surge in Covid-19 infections.

Underpinning the summer insouciance is the reassuring knowledge that central banks and governments will again step in to cushion the crunching economic blow of the pandemic and steady stock markets when they start to sway.

By early this week, investors were confidently betting that policymakers, particularly in the US, were ready to ring the bell for another round of fiscal stimulus, sending the S&P 500 index to within a whisker of its all-time high.

Providing much needed stock-market support beyond the metaphorical boxing-ring ropes is “Tina” – the acronym for there is no alternative. As yields on government and highly rated corporate bonds have collapsed to near zero, or turned negative, investors have switched from bonds to “safe” technology and other so-called quality growth stocks. 

In the US, it means the top five companies – Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) – now account for more than 20% of the S&P 500 (up from 17% in January). This level of concentration does not provide investors with broad exposure to the US economy and passive index-tracking investors in particular are potentially exposed to what looks increasingly like a Big Tech bubble.

There will be a reckoning at some point, but there are far wider financial implications from the global monetary and fiscal response to the pandemic that will dwarf a bubble in tech eventually getting pricked. 

How to diversify?

I pointed out in my last column that prudent private investors once relied on a classic 60/40 equity/bond portfolio to provide them with the benefits of diversification. When equities fell, bond prices would rise, and vice versa. With bond yields now virtually non-existent, the temptation is to succumb to Tina’s charms and “go all in” with equities because the benefits of the insurance policy that bonds once provided – an income – have largely disappeared.

Fans of Tina are also comforted by the evidence of the past 11 years that shows that when things get dicey and asset prices fall, central banks led by the US Federal Reserve step in and splash the cash.

Investors who do not buy the Tina argument and still want to pursue diversifying strategies are being forced to travel further up the risk curve in search of diversifying assets and in most instances they are forced to pay a high price for them. That is particularly true for investors seeking an income.

Infrastructure and renewable energy infrastructure trusts are a case in point. These generally pay the sort of income, currently around 5%, that not so long ago one might have reasonably expected to receive from a 10-year government bond. 

However, this income – which does not come with a government guarantee – does not come cheap.  The average premium to net asset value (NAV) is around 18%, but a popular trust such as Renewables Infrastructure Group (LSE:TRIG) currently trades on a premium of 23.6%, higher than before the coronavirus crash.

The dangers of just how swiftly high premiums can evaporate, eroding confidence as well as capital values, were starkly illustrated in March during the “dash for cash”, when those high premiums rapidly collapsed and turned into big discounts. Shares in TRIG itself fell from a 20% premium to a discount of 11.7%, sending the shares down around 30% in two weeks.  That’s not the sort of performance that investors in relatively safe fixed assets would have expected. 

In fixed income, to get the yields that relatively safe bonds once provided, investors need to move further into high yield and junk bond (non-investment grade) territory. This is largely where central banks have been intervening in an effort to ensure the 2008-09 credit crunch is not repeated. It has clearly worked because the average yield on US junk bonds has more than halved from nearly 11.5% in March to 5.4%, according to Ice Data Services.

With the backstop of central bank support, there are undoubtedly opportunities to exploit among higher-yielding bonds, but it is an area best left to the professionals. Aided by the stimulus onslaught, many high-yield bond funds have recovered nicely. They include interactive investor Super 60 funds such as GAM Star Credit Opportunities £, which focuses primarily on the junior debt issued by banks and other financial companies, and Royal London Sterling Extra Yield, which includes unrated bonds in its portfolio. They currently yield 4.3% and 5.6%, respectively, and have good longer-term performance records.

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A few investment trusts also look attractive diversifiers. Although veteran bond investors Paul Read and Paul Causer are stepping back from the day-to-day management of Invesco-managed City Merchants High Yield (LSE:CMHY), co-manager Rhys Davies is also a seasoned bond investor. The trust currently yields 5.7% and trades on a 5.2% discount to net assets.

A more intriguing option is CQS New City High Yield (LSE:NCYF), a £233 million trust run by equally seasoned bond investor Ian Francis. This high-income specialist yields an eye-watering 9.3%, which indicates that it is not for the nervous. Nevertheless, the shares trade on a premium of around 3%, which is far lower than many other specialist income-producing trusts. But what adds to the attractions of this trust are its revenue reserves: at £17.3 million and rising this equates to almost a year’s worth of the previous year’s total dividend, which is a handy cushion.

Like the aforementioned infrastructure trusts, these high yielders were highly volatile in this year’s dash for cash. NCHY shares fell 50%-plus at the height of the market scare before staging a strong recovery, and Royal London Sterling Extra Yield fell by around a quarter before bouncing back.

Bond funds and trusts such as these will certainly appeal to adventurous income-seeking investors but those who simply want to diversify away from equities should also consider lower-yielding Super 60 choices, such as Jupiter Strategic Bond, Marlborough Global Bond and M&G Global Macro Bond. 

‘Cheap’ inflation hedges 

Bond funds have a place in a diversified portfolio while inflation remains in abeyance. Inflation is the mortal enemy of bonds, because it erodes the value of the fixed income that most bonds pay, as well as their capital value if they are held to maturity, particularly if the bonds are trading above par value. 

That brings gold into the diversifying asset mix. The fear of an inflationary shock is one of the factors that is driving its powerful run this year. In January, investment bank Goldman Sachs predicted gold would touch $2,000 an ounce within the year and last week it rose to an all-time high of $2,063 per ounce. The bank has since updated its 12-month forecast to $2,300. 

After a 40% gain this year one could argue that gold, too, has become an expensive diversifier, but there are ways to buy gold and gold-mining shares on the cheap. The simplest way for investors to buy their gold exposure is via an exchange traded fund such as iShares Physical Gold. However, as with high-yield bond funds, more adventurous investors can get their precious metals diversification via investment trusts that trade at a discount to NAV. 

The largest of these is BlackRock World Mining (LSE:BRWM). This £900 million trust has around 35% of its assets in gold and gold-mining companies, which offset its exposure to more cyclical industrial metals. It also pays an income, with the 5.3% yield covered by a year’s worth of revenue reserves, and it trades on a 10.6% discount to NAV. 

More speculative and direct exposure to gold miners can be accessed through Golden Prospect Precious (LSE:GPM), a £41 million trust trading on a 15% discount, while open-ended funds worth a second look include Investec Global Gold and LF Ruffer Gold.   

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Sebastian Lyon, chief investment officer of Troy Asset Management and manager of capital preservation-focused Personal Assets (LSE:PNL), recently told ii podcast listeners that on a five-year view, inflation is a very real threat.

As he concedes, high inflation “may or may not happen” but it would have material implications for both fixed-income and equity investors. PAT’s inflation insurance policy is to have a large slug of its assets in US Treasury Inflation Protected Securities (TIPS). But it also holds 12% in gold and gold-mining shares. 

Last, but by no means least in the armoury of diversifying assets, investors should not forget plain old cash. Not only does cash provide food on the table, it gives you the means to buy shares when they get really cheap. 

That is worth remembering if you suspect that the Federal Reserve can’t prop up punch-drunk markets forever.  

The author was editor of Money Observer between 1998 and 2015. He holds shares in BRWM and GPM. 

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