Traditional Income Is Dead, Long Live Alternative Income

Nick Scullion

Traditional sources of investment income are facing structural issues while the alternative income sector is booming. Identifying sectors with the most attractive risk-adjusted returns is the real challenge.

UK Equity Income has been hugely popular with investors throughout much of the last decade, and with good reason. A look at the latest data published by the Investment Association shows that the UK Equity Income sector has delivered 186% growth over the previous 10 years. This equates to 40% more than UK Equity and Bond Income, 80% more than Strategic Bonds and 84% more than Corporate Bonds.1 However, UK Equity Income is no longer the obvious choice for investors seeking income, as traditional dividend paying equities are likely to remain in a sustained period of volatility due to Brexit related uncertainty and swings in Sterling. The other two traditional income producing asset classes, property and bonds, have their own structural issues with property funds facing lock-ups due to redemptions and bond funds languishing in the eleventh year of sub 1% base rates.

As traditional income products have withered on the vine, a myriad of alternative income products has sprung to market. Investors seeking a regular and predictable income alongside true diversification have to work a bit harder to analyse some of the less well understood asset classes. For those who make the effort, there are still ample streams of income available from asset classes such as peer-to-peer lending, asset leasing, infrastructure, renewable energy and alternative property products like healthcare and social property.

The challenge investors now face is determining which of these asset classes is best placed to deliver a regular income with the most attractive risk-adjusted returns. The infrastructure and renewable energy asset classes provide investors with characteristics that are largely unavailable elsewhere, and in my view provide opportunities for superior risk adjusted returns compared to other sources of alternative income. Infrastructure and renewable energy projects typically benefit from long-dated, inflation- linked cashflows underwritten by the government or another public sector counterparty, characteristics that make the 5%+ net yields in the sector and true diversification a compelling investment proposition.

Bull

  • Increased focus on the transition to a green economy is boosting support for renewable energy
  • Returns from infrastructure projects are largely uncorrelated to equity markets

Bear

  • Brexit related Sterling volatility has the potential to cause capital losses and erode income from UK equities with material earnings in foreign currencies
  • Dividend growth for cyclical equities is difficult to predict

Nick Scullion is the Head of Foresight Capital Management at Foresight Group and Co-Fund Manager to the FP Foresight UK Infrastructure Income Fund