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Asset Management / Wealth Management
Why income strategies may be dangerous for investors in the current market environment
Yield-focused strategies may be particularly prone to clients’ behavioural biases
Bayani S Cruz 5 Oct 2017

A lot of fund managers in Asia, the UK and Europe are offering investors income strategies as the best solution in the current market environment where yields are very low.

But this may be dangerous, particularly for investors who are looking to remain invested at all times and draw income from their savings, according to Anthony Gillham, co-investment director of multi-asset, Old Mutual Global Investors (OMGI).

“In this kind of market environment, we have to be careful that we don’t end up stretching for yield or reaching for yield for our clients, who may actually be less able to take on additional capital risk,” says Gillham, in an interview with The Asset.

Gillham cites the example of Taylor Wimpey, a UK house builder which is a constituent stock of the FTSE 100. Taylor Wimpey has recently yielded 7%, but has seen a drawdown of nearly 50% in terms of its capital, in the recent past.

“While we’re seeing this demand for income or yield, it can be quite dangerous in the current environment because you’re actually having to stretch for that yield. You’re actually having to acquire a lot of capital volatility, and arguably it’s the clients who tend to be looking for income who don’t want – or least want – to take that capital volatility. We’re seeing demand for income but we have to be quite cautious,” says Gillham.

An income- or yield-focused investment strategy is also prone to the behavioural biases of individual investors who are more focused on a portfolio’s return, and less focused on its risks. Gillham cites studies indicating that investors react differently to potential gains and potential losses.

“When markets are on a bull run, clients want to invest and to add more to their portfolios, but potentially that’s the wrong time to do it. They jump on that momentum when the markets are getting more and more expensive. Conversely, when the markets are falling, we often find that the clients want to sell out of it. They kind of panic themselves out of the markets. If you take a step back and think about that, that’s exactly the wrong time to sell,” says Gillham.

To avoid investors’ behavioural biases from impacting their portfolios, OMGI uses a risk-targeted multi-asset investment strategy.

“All of our portfolios have a risk target. This helps clients to not focus on returns but to focus on investing in a portfolio that’s within their risk tolerance level. When clients have invested in a portfolio that’s within their risk tolerance, they’re far less likely to get panicked out of that investment. It means they are far more likely to hold on to that exposure, and so over the longer term that’s going to give a better result for the client,” says Gillham.

OMGI has four risk-targeted multi-asset funds that are built to have the same underlying holdings and the same tactical asset allocation, but have different levels of risks.

“We have a range of strategies, rather than having just one flagship fund. This allows us to risk-target our asset allocation. And what that allows our customers to do is, rather than just having one fund to pick from, which is the returns-focused way of doing things, they can pick the level of risk that’s most appropriate for their risk tolerance level,” says Gillham.

The risk-targeting for OMGI’s four multi-asset funds is done by setting a target for the level of risk for each fund, based on the fund's volatility. For example, one of its funds has a target volatility of 10.5%.

“What we do is we take the expected levels of risk, return and correlation for all of the different asset classes that we have in this fund. Then we optimize a portfolio, using mean-variance optimization, to work out the asset allocation that’s going to give us the best level of return for a volatility of 10.5%. That’s the process for determining how much equity, how much fixed income, how much hedge funds and how much cash, for example, we need to have for our different funds,” says Gillham.

Once the asset allocation is determined, OMGI uses a process called VTEC to fill in the asset allocation. “V” stands for valuation, “T” stands for market technicals, “E” stands for macroeconomic indicators, and “C” stands for corporates.

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