Most people would say they could do with more of two things – time and money.
Ever since the global financial crisis, the ultra-loose monetary stance of central banks globally has sapped investors’ ability to find income in the usual places.
However, there are still plenty of ways to find inflation-beating sources of income, and one of the best has to be equity markets.
The relentless pursuit of economic growth – and higher inflation – by central banks in recent years has driven yields to record lows across most of the developed world. Now, lack of inflation or outright deflation, reduced investor risk appetite, and de-risking from institutions such as pension funds, have made the problem even worse. Nowhere is this more apparent than in Europe.
Thanks to the willingness of the European Central Bank (ECB) to buy bonds with a negative yield under the bond-buying programme, yields across the region have plunged into negative territory.
Germany, France, the Netherlands and Ireland all have government bonds markets where some are trading at negative yields. In fact, more than a quarter, or €1.4trn (£1trn), of government bonds in Europe have a negative yield.
The income solution to the yield puzzle has been to move further along the fixed income risk spectrum and into a wider pool of positive-yielding assets.
But even that pool is starting to look a little smaller, as it’s not just government bonds that are being pulled into the realm of negative yields. One per cent, or ¤11bn, of the European corporate bond universe is currently trading with negative yields.
Unfortunately the picture is unlikely to change any time soon, and yields on longer-dated government bonds are likely to remain low.
One of the biggest reasons for the low yield is the persistent demand to own bonds from less price-sensitive buyers. The ECB and the Bank of Japan will purchase vast amounts of government bonds, pension funds are going through a multi-year de-risking process, and banks and insurance companies are being forced to own them for regulatory reasons.
While these various pressures mean investors can still hope to earn positive total returns on bonds as yields are driven down from their already low levels, the very high level of prices means the potential rewards for holding these assets are much lower than they were – and the risks of a reversal correspondingly higher. Sooner or later, nominal and real rates will start to rise. This could cause market volatility, as well as capital losses, particularly for holders of long-maturity debt.
In this environment, equity dividends look like an increasingly obvious solution to the income problem. European equities are an excellent hunting ground for the income chaser.
The ability to capture dividend yields in the region of 4.5 per cent from top-performing European stocks (as of the end of March) looks compelling relative to the incredibly low average yields on offer from traditional fixed income.
