Equities, bonds and cash are usually present in any portfolio, with each being able to provide income for investors.
But when it comes to yield potential, risk and growth prospects, equity income investing differs markedly from bonds and cash, notes Robert Plant, manager of the Universal MAP Income Fund at Columbia Threadneedle Investments.
“While global equity dividend yields sit at around 2 per cent, bonds currently offer higher returns with the 10-year UK gilt yielding 3.8 per cent, and the US 10-year Treasury at 3.7 per cent,” he says.
“Investment-grade bonds add an extra 1 per cent, and high-yield bonds can provide more than 3 per cent above sovereign bonds. For income-focused investors, bonds typically offer more predictable and stable returns, with lower risk than equities.”
But Plant says that equity income investing, particularly in the UK, can still be appealing due to higher dividend yields of around 4 per cent, driven by value sectors like oil, mining and banks.
Stuart Taylor, a senior fund manager in the UK equities team at Canada Life Asset Management, similarly describes the domestic market as one that is “attractively valued”.
“The UK market offers some great yielding stocks, and could well be set up for a prolonged period of attractive returns for income seeking investors,” he says. “Equity investors however need to be aware of their portfolio’s sensitivity to bond yields, even if they can’t necessarily measure it precisely.”
At the other, low end of the risk curve, Taylor notes how cash protects capital value and provides a steady stream of interest income, although its return often fails to keep up with inflation.
Meanwhile fixed interest securities, which sit higher up the risk curve, can provide predictable returns if held to maturity and the issuer does not default, he adds.
“Fixed income securities do provide more certainty [than equities] when held to maturity, with a known return at the time of purchase,” says Taylor.
“By contrast, equities have no maturity date, so dividend payments can theoretically continue indefinitely, allowing for the possibility of growing returns. But dividends are not guaranteed, and companies cutting their dividends is far from a rare occurrence.”
Equities, unlike bonds, also provide the potential for capital growth, highlights Plant at Columbia Threadneedle, although come with greater volatility in addition to the risk of dividend cuts.
“Historically, dividend yields have decreased globally, from around 5 per cent in the first half of the 20th century to much lower levels today, as many companies prefer share buybacks over dividend payments,” he adds.
Indeed, when it comes to the latter, Plant says the main challenge for equity income investors is balancing the pursuit of higher yields with the risk of dividend cuts.
“Stocks with yields above 5 per cent often signal either financial distress or a likelihood of future cuts, so careful analysis of a company's fundamentals and balance sheet is crucial,” he says.
