This month marked the sixmonth anniversary of pension freedoms, and today’s retirees are having to make increasingly complex decisions about the future of their finances.
With annuities no longer the only option, investors can turn to a multiasset approach, which can deliver a stable and attractive monthly income on a sustainable basis. In the current volatile environment, this may seem more appealing for savers who are looking to maintain their lifestyles through retirement. Instead of trying to pick winners in certain markets, a blend of asset classes provides a more diversified portfolio to prevent against potential loss of future wealth.
As fund managers, it is our job to look at all asset classes to determine the returns we are getting for the risks we are taking. In a world where interest rates are distorted by central bank policy decisions, however, achieving any form of return is challenging. If we look at bond markets today, it seems as if the risks are not conducive to the returns. This will become more serious if inflation starts to rise, which is essentially what central banks worldwide are trying to achieve. As a result, alternative asset classes are looking increasingly attractive.
DIVERSITY OF ALTERNATIVES
The alternatives landscape has changed considerably compared to before the financial crisis, when it was all about hedge funds that used leverage to generate returns. Today, alternatives also include more structured and less economically sensitive assets, such as infrastructure, renewable energy, and to some extent real estate.
Investments in these real assets offer bond-like returns but with higher yields. For example, renewable energy assets have strong cash flow generation, high payout ratios, and high government subsidy support. The combination of these three factors means you have very stable cash flows with a high degree of certainty around them. While they do not necessarily offer world-beating annual returns, they do deliver solid stable returns that are attractive compared with government bonds, yet a significant proportion of their cash flows effectively come from the same place.
CERTAINTY OF INCOME
Renewable energy assets, among other alternatives, are appealing due to their revenue streams not being dependent on the economic environment: as long as the sun comes up and the wind blows, the assets will generate power. This provides a higher degree of confidence in the sustainability of these income streams than those of traditional asset classes, which is perhaps why renewables have held up in the recent turmoil.
We are in the midst of an economic experiment in which central banks have, through unconventional methods such as quantitative easing, unsustainably driven up asset prices. Against this backdrop, it is important to truly understand what you own and why you own it, and be wary of those assets whose values have been distorted.
Renewable energy assets and other alternatives such as infrastructure have been comparably better-shielded from these unintended consequences, being somewhat further removed from the assets directly affected by state intervention and quantitative easing.
However, one still has to be careful of the business model and structures of these companies, as some more complex strategies, such as renewable energy yieldcos in the US, have seen significant falls in their share prices over the last few months (c -50 per cent), highlighting the importance of active fundamental stock picking.
INFRASTRUCTURE AND REAL ESTATE
Infrastructure spend will reach $9 trillion a year by 2025, and $78 trillion is expected to be spent globally between 2014 and 2025 in both developed and emerging markets. With global public sector organisations facing increasing cost pressures, many are now seeking new private investment and funding for infrastructure development, creating an ever-wider range of investment opportunities.
The trend towards deregulation of previously state-owned utilities, embraced by markets such as the UK, has also opened up new avenues of opportunity for investors keen to gain exposure to this sector. With interest rates and bond yields at historic lows, infrastructure investment can deliver competitive returns while adding diversification to portfolios.
Real estate is another attractive asset class within alternatives, because you can have sustainable cash flows even in a downturn. In particular, real estate in some emerging markets looks favourable over the longer term because population dynamics are likely to drive higher demand as a middle class is developed. Infrastructure in emerging markets benefits similarly. In contrast, a lot of high street real estate in developed markets was built before the internet. With rapidly growing e-commerce, there is less demand for such property.
For those looking to tackle their retirement income, alternatives can provide lower risk, sustainable cash flows and diversification. At the moment, alternatives form between 15 per cent and 40 per cent of our Multi-Asset Income and Multi-Asset Diversified Return funds. Our multi-asset managers work closely together, drawing on the analysis of our global research team and conducting their own analysis in order to ensure that their individual investment decisions are built on a higher level of conviction.