The traditional asset allocation approach for clients is predicated on the idea that bonds and equities move inversely to each other, and that bonds are owned for income-generating reasons while equities are predominantly owned for reasons of capital gains.
But the decade following the financial crisis usurped this notion, as bond buying by central banks sent the prices of fixed income assets much higher, and so yields lower, meaning the case for bonds as a source of income dried up.
At the same time, many of the traditional income-paying equity sectors performed relatively poorly compared with non-income paying equities, meaning a relatively narrow part of equity markets was delivering the capital appreciation.
Investors therefore faced the choice between buying the equities that can pay a dividend – and then being forced to explain to clients why they own the underperforming parts of the equity market – or else own the assets that do not pay an attractive level of income.
Alex Hardy, a multi-asset investor at Momentum Global Asset Management, says the UK stock market underperformed relative to the rest of the world for a long time due to many investors choosing to buy the non-yielding technology stocks in the US rather than the income payers in the UK.
Michael Walsh, a multi-asset investor at T Rowe Price, says this determination to square a circle that may not have been capable of being squared led to “some equity income portfolios putting 25 per cent of the capital into tech stocks in the name of diversification”.
But Hardy says that as interest rates and inflation have risen – and are unlikely to return to the previously record low levels – it is likely that the case for UK equities over the longer term will be stronger than it was during the era of quantitative easing.
Guillaume Paillat, multi-asset investor at Aviva Investors, says the key to equity exposure that combines income and capital growth potential is “not to be too fixated on whether a fund is an ‘equity income fund’ or just an equity fund that has some stocks that pay dividends, and to be relaxed about including the latter even in an income portfolio”.
Split decision
David Coombs, head of multi-asset funds at Rathbones Unit Trust Management, says: “When bonds were falling in price, that was creating a capital loss on portfolios, and one almost had to own growth equities to mitigate that capital loss, but this year as bond prices have recovered somewhat there has been a bit less need to own the growth equities.
"In terms of the bonds we are owning now, we are sticking with short-duration bonds; you can get 4-5 per cent on some of those and the capacity for capital reduction is much reduced, which gives you more flexibility in terms of the equities you may want to own.”
