Multi-asset income funds in a world of high interest rates

ASIAN investors’ strong preference for income-generating investments is well known. While dividend-paying stocks have traditionally been popular, multi-asset income funds have also gained enormous success in Asia in the prolonged low-interest-rate environment following the 2008 global financial crisis.

These funds typically offer attractive annualised dividend yields in the mid-to-high single digits, distributed monthly. They can also provide asset-class diversification and capital growth potential, making them an appealing product for income investors.

However, the return of more normalised interest rates poses a challenge for these funds, as income seekers turn to low-risk products such as term deposits or money market funds that easily offer a 4 per cent to 5 per cent yield. Morningstar recently published a study, titled Multi-Asset Income Funds: Navigating a Shifting Landscape, which examines whether multi-asset income funds are still relevant for income investors, and how they are adapting to the new environment of higher yields.

Should income seekers just go for cash/money market funds?

Investors should carefully consider the trade-offs associated with short-term instruments, such as cash deposits and money market funds. First, their yields can fluctuate. Yields may fall when central banks cut rates in an economic downturn, exposing investors to reinvestment risk as they roll over their term deposits, or as money market funds continually reinvest their underlying securities.

Second, the instruments’ inability to offer upside potential suggests a dismal chance to beat inflation over time.

To achieve their income objectives, investors should weigh the long-term implications of their investment decisions and strike a balance between growth and defensive assets. With fixed-income assets now offering higher yields and better diversification potential, the outlook for multi-asset funds has improved, and they can achieve higher payouts without taking on excessive risks.

The improved buffer against downside risks provided by defensive assets today also preserves flexibility for the funds to capture capital growth opportunities in riskier assets, such as equities and high-yield credits.

Adapting to a higher-yield environment

Among the multi-asset income funds available for sale in major Asian fund markets such as Hong Kong and Singapore, there has been a general trend of higher distribution yield and higher allocation to investment-grade bonds since the start of 2022.

This reversed the previous downtrend from 2020 to 2021, when central banks cut rates amid the Covid-19 outbreak. Bond yields compressed to historical lows, forcing fund managers to take more risk through higher-yielding securities, such as high-yield credits, to maintain competitive payouts.

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Overall, multi-asset income strategies now do not need to stretch as much as they needed to in the last few years to generate a decent payout for investors. They also have more levers to pull to balance risk and return, such as high-quality duration, investment-grade bonds and cash.

Beyond the headline distribution yield

High distribution yields may be enticing, but they can also be illusory as they are not equivalent to returns and come with higher levels of risk. Our study reveals that multi-asset income funds with a higher payout experienced a bigger decline in their capital over time. The reduced capital base often leads to lesser participation in future growth and importantly, lower income distributions in absolute amounts.

Allianz Income and Growth is among the most popular multi-asset income funds in Asia, and boasts a 9 per cent annualised dividend yield. Typically, however, 75 per cent of its payout relies on unpredictable short-term capital gains, and the fund courts high downside risk as it invests equally into three highly correlated asset classes – growth-oriented equities, convertibles, and high-yield credits. For instance, it lost 20 per cent in 2022.

Such a product design exacerbates capital erosion risk in volatile markets, which reduces the fund’s capital base and limits its scope to provide a stable income. In fact, the fund most recently reduced its monthly distribution in April 2023 – the fourth reduction since 2016.

Be selective

Multi-asset income funds remain relevant for income seekers, given their improved investment prospects. But it is crucial to balance between yields and risks to achieve a more consistent income and capital growth.

Notably, these funds are not homogeneous, and investors must select a fund that matches their investment objectives and risk tolerance.

It is equally important to select managers who are prudent in their payouts to safeguard investors’ long-term outcome and have proven their flexibility in adjusting their portfolios through changing market conditions.

The writer is associate director for manager research, Morningstar.