Income has been a focus for investors as the world has experienced record low interest rates, putting pressure on income-producing assets.
Although there’s a view that it’s hard to identify assets that produce a sound level of income, that’s not strictly true. It’s possible to identify assets that produce income, but investors have to take on relatively more risk to achieve levels of income that in the past required much lower risk.
At the same time, capital appreciation for many assets has risen as income levels have plateaued.
Nevertheless, there are many opportunities for self-managed super fund investors to identify assets that offer a good source of income. For instance, there are assets that produce income that have been subject to a cleansing process recently. Some areas of the energy sector are examples. The idea is to look for assets where there's still potential to earn income in sectors where bad news has already been priced into values.
If an income-producing sector or asset is under pressure, it is likely dividends will be cut and the market may have already priced that into asset values. At that point savvy investors look for sectors that have experienced bad news, where conditions are starting to improve.
Undertaking substantial research based on extensive analysis is key to identifying assets in this category.
At AMP Capital, we look at markets and opportunities through five different lenses. It allows us to objectively analyse the potential for assets to produce income in the world where there's an oversupply of information available for SMSF trustees.
It can be difficult for SMSF trustees to sift through such a huge amount of information that’s available about markets and income-producing assets. There’s so much new information to process each day it’s easy to become overwhelmed. Which is why we break down the information we can access and apply the following five drivers to find sources of income.
1. Opportunity to deliver value
We are always looking for assets that are undervalued by the market, that have the potential to generate income and capital growth in the future.
2. Earnings cycle
We are looking for assets at the point of their earnings cycle where there is the potential for improvement.
3. Central bank actions
Central bank actions have an enormous effect on markets and sectors where income matters. Changes to interest rates as well as monetary policies such as the introduction of quantitative easing have benefited some parts of the market such as technology stocks, whereas other parts of the market like energy and financial services have not benefitted.
However as central bank policies change over time, different assets will be affected in different ways.
Sentiment often indicates how crowded the market is and how difficult it is to achieve a positive rate of return. If the market is crowded, risk is heightened. Whereas that’s not the case when there are fewer participants in the market.
Optimism in the crowd is also a potential problem; the risk is investors are not thinking about the asset class objectively and underlying market conditions are deteriorating.
Looking at markets from a technical point of view requires assessing the information the asset or market’s price gives you. For instance, elevated prices might indicate the market is overbought and ready for a correction. In contrast, depressed prices might indicate the value of the market is ready to rise. What investors should look for are signals that confirm or deny their view.
It’s easy to become overwhelmed by all the information in today’s markets and miss out on good opportunities. At AMP Capital, we filter information using these drivers and SMSF investors can use this as a guide when forming their own thinking about how to generate income for their funds.
It’s a way of making sense of the world and avoiding investment paralysis when there is so much information available to guide SMSF trustees in their thinking about their fund.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.