Robert Mead of PIMCO (pictured) focuses on fixed interest, while Steven Bennett of Charter Hall separately discusses commercial property.

Low yields and ageing populations are fuelling demand for retirement income solutions globally. At the same time, popular sources of income are under pressure – term deposit rates are declining and Australian bank dividends are being cut.

Investors cannot rely on the old barbell approach of holding term deposits along with equities and direct property to deliver income and total return. We believe they should consider fixed income.

We construct income-generating portfolios using a broad range of bonds issued across multiple sectors from government bonds to investment-grade bonds to higher-yielding structured credit in domestic and global developed and emerging markets.

We divide the portfolio into two general components: one invested in higher-yielding assets that tend to perform well if economic growth is stronger than expected; the other invested in higher-quality assets that should perform well if economic growth is weaker than expected.

Attractive income opportunities right now

Although we have a positive outlook overall for 2020, if the environment were to weaken, as it did in late 2018 and early 2016, we think central banks may not have the tools to deal as effectively today with a slowdown in growth or a dislocation in the markets.

As a result, we are cautious on generic corporate credit, aiming to find resilient areas of the market where we can maintain yield without increasing risk. We are finding those opportunities in consumer and housing-related sectors and mortgage markets.

It has been more than 12 years since the onset of the US housing crisis and many housing-related investments now have stable cash flows, yet their credit ratings and yield spreads often do not reflect this.

In our view, the fundamentals in US housing are strong: household formation is increasing, housing supply is tight, mortgage rates are low and incomes are rising.

For the higher-yielding portion of our income portfolios, we continue to find value in US non-agency mortgage-backed securities. These are bonds backed by residential loans that are not supported by some form of government or private guarantee. There has been continued deleveraging in this sector as borrowers pay down their loans, in contrast to corporate credit where companies have increased leverage.

In the higher-quality portion of the portfolio, one opportunity that has been very attractive over the past few months is US agency mortgage-backed securities, which are also backed by residential mortgages but have a US government or US agency guarantee. These are high-quality securities with an attractive liquidity profile.

The sector significantly repriced recently given the movement in US interest rates in 2019, creating an attractive opportunity.

We continue to like the financial sector – banks, in particular. They tend to have more price volatility than industrials, but overall the stricter regulatory environment since the financial crisis has made banks fundamentally strong. Our exposure to UK banks, for example, was a contributor to performance last year as Brexit concerns subsided somewhat and spreads tightened.

Income investing for the long term

PIMCO focuses on the long term, constructing income portfolios that generate a consistent but responsible income stream while maintaining flexibility. We are willing to give up a little total return in the near term while seeking to provide investors with the long-term resilience they expect from our strategies.

It is a patient approach. 

Commercial property less understood as quality asset

By Steven Bennett, Charter Hall

Australians’ love affair with property, particularly residential, is well documented. Yet many are less familiar with commercial property such as office, industrial and logistics.

When it comes to income, residential property usually performs at the lower end of the scale, with annual net income typically in the range of 2-3 per cent per annum gross (before running costs). Then there are the ongoing recurring costs, including land tax, council and water rates, insurance, repairs and maintenance, property management and strata fees. All of these decrease the income received by the investor even further.

Many people are unaware they can invest in Australian commercial property that can deliver significantly higher levels of income, without the investor having the burden of managing the day-to-day matters of a residential property. They can invest in commercial property through a quality unlisted direct property fund for an initial investment of as little as $20,000.

Charter Hall’s unlisted direct property funds invest in commercial property and currently have income distributions ranging from 5.4 to 6.8 per cent per annum, paid either monthly or quarterly. They also have the potential for capital growth.

Unlisted direct property funds typically invest in institutional-grade commercial property. Office buildings, healthcare properties, Bunnings assets and industrial and logistics buildings are some of the most popular sectors. These assets are targeted by large Australian superannuation funds, offshore pension funds, sovereign wealth funds and sophisticated investors for their own investment portfolios.

Charter Hall specialises in making these same quality commercial property assets available to individual investors, high-net-worth investors and self-managed super funds.

When considering an investment in commercial property, investors should be aware that not all direct property funds carry the same risk profile. Charter Hall is focused on acquiring property at the top end of the quality range and the funds are conservatively geared. The focus is on achieving regular and growing income streams, properties that are leased to high-quality tenants, and long-term leases with fixed annual rental increases.

There may be higher returns on offer from other direct or unlisted property fund managers, but that is usually because they are more aggressively geared and own assets with a higher risk profile.

Investors should be aware that unlike listed property trusts, which trade on ASX and can be bought or sold each day, direct property funds are unlisted. Unlisted funds usually have an investment term of three to five years, which means that except for any limited withdrawal offers, you remain invested in the fund for the entire term.

Most investors, however, do not require 100 per cent liquidity in their portfolio, which is also why they have historically been content to own residential property. Besides, if you have a quality property investment providing regular income above 5.4 per cent per annum – which is lowly correlated with other investment classes such as equities – why wouldn’t you consider Australian commercial property?