The Sustainability of Income
The importance of equities as a source of income
The sustainability of income remains central for many of our investors; they rely on a diversified source of income streams to ensure that income objectives are met. Government and corporate bonds historically provided the core of income generation, alongside property and infrastructure investments. However, the decline of yield on many of these instruments, especially in the fixed income asset class, has made the sustainability of income from equities ever more important.
The increased attractiveness of equities as an income source comes with some challenges. High yielding equities have been in favour for some time and the resultant high valuations for those stable, cash generative companies that return capital to shareholders through attractive dividends means that investors should tread carefully. We do not think it is sufficient, for example, to buy uniformly those equities with high yields, as it is the sustainability of dividends that is of importance. Therefore, an understanding of the attributes of each company is required.
Dividends are paid out of ‘excess’ earnings, after loan interest and investments have been made, and if earnings fall then it follows that dividends can be cut - often with little warning. The sustainability of equity income is, therefore, closely tied to the health and strength of individual companies and the economy; investors need to understand this relationship. Identification of those companies which are able to sustain their dividends is necessary through detailed analysis.
What is important for our clients is not just the level of income but growing income in real terms. Therefore it is vital that we select companies which are able to pay a progressive dividend, most likely from a healthy stream of underlying cashflows, which coincidentally often supports a higher capital value of those companies.
Unsurprisingly, perhaps, the list of quality dividend paying companies is not extensive, therefore, selecting from a global pool allows for greater diversification of income streams and currencies to source that income. It is now the case, for example, that a number of Asian companies pay an attractive dividend whilst still growing strongly and displaying a reasonable valuation.
While income hungry clients should remain well served with a multi-asset portfolio that provides a number of sources of income, our work on equity income provides us with a great deal of comfort that we are able to offer a sustainable income level.
By Ian Enslin
The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.
Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.
The value of investments and their strategies may fall as well as rise. Capital security is not guaranteed
You should note that yields on investments may fall or rise dependent on the performance of the underlying investment and more specifically the performance of the financial markets.