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Sustainable Income: built to last

Lucie Majstrova, Investment specialist

Key Points

  • Our Sustainable Income portfolio focuses on delivering a resilient, long-term income stream that grows with inflation
  • It invests globally in various asset classes including fixed income, infrastructure and equities 
  • We invest solely in countries and companies that we think are compatible with a sustainable economy, as they stand the best chance of generating a strong income in the future.

All investment strategies have the potential for profit and loss, capital is at risk. Past performance is not a guide to future returns.

With interest rates on easy access cash deposits above 4 per cent in the UK, one may question the need for income investing. In truth, the forecast yield on our Sustainable Income portfolio is in line with rates seen on cash deposits and below the yield on UK gilts.

The reason is inflation. High nominal yields on cash and gilts appear attractive. But the income they generate cannot keep up with the increasing cost of living.  

Our Sustainable Income portfolio was set up to deliver what it says on the tin: a sustainable income stream. To us, this means an income that grows with inflation over time. We aim to produce that by investing globally across nine different asset classes, in companies and countries that we believe are adapting to the world’s challenges to be the best income payers of tomorrow.

We seek to deliver the highest possible level of resilient natural income (from dividends and coupons), that can be relied on to meet financial goals and commitments for many years.

Income for the long haul

The requirement for income that lasts is not going away – from individuals in ever-longer retirements, or charities looking to fund their activities. But how can they generate income that can be relied upon for decades to come?

We believe focusing on long-term income growth is the answer. Investing in a variety of asset classes allows us to match their different characteristics so we can deliver a resilient income today and grow it over time. Thanks to increased interest rates, fixed income, in general, offers more attractive income levels. Our global reach allows us to look beyond traditional fixed income asset classes. Right now, we are particularly excited by opportunities in emerging market debt, where central banks in many countries have been quick to fight inflation and are set to reap the rewards.

When it comes to stable, inflation-matching income growth, we look to real asset classes: infrastructure and property. Our infrastructure investments were very valuable last year, delivering diversification benefits at a time when both equities and fixed income struggled. The income resilience that is often coupled with contractual linkage to inflation is a great match for our objectives, so while we have taken some profit since last year, it remains a key part of our strategy.

Last but not least, the engine of real income growth is equities. That is, if you pick the right ones.

Long-term income, not short-term yield

To fully reap the benefits of our broad opportunity set, we invest in a bespoke portfolio of hand-picked investments within each asset class. We test them for resilience and their potential to be the best income payers of tomorrow.

When the objective is finding income that can last for decades, it’s crucial to think about an investment’s potential five or ten years from now. While that may sound obvious, fascination with yield leads many ‘income’ investors to focus on this year’s dividend and coupon payments. They often take on significant risks to both income and capital in the process.

The most recent evidence of this ‘yield first’ approach faltering came at the beginning of the pandemic, when we saw many of the UK’s largest dividend payers cut or cancel their dividend payments. Since then, many of those payments have either not returned or have resumed at a more modest level.

That’s why we focus on how a company’s dividend will progress over a longer period. Take the Danish pharmaceutical company Novo Nordisk, a holding since inception in August 2018. With a low current dividend yield, most income investors would give it a miss. However, since 2018 the company has grown its dividend by over 40 per cent and enjoyed significant capital growth – this is exactly the type of income investment we look out for. The trajectory of its dividend potential remains as exciting as ever, which is why it is still among our largest equity holdings.

Fit for the future

Sustainability has two meanings. Will an investment’s income stream prove to be sustainable over long periods of time? And is it sustainable from ESG perspective? We believe the two are inextricably linked. The best income payers of tomorrow will be forward-thinking companies that are successfully adapting to meet the needs of a sustainable economy.

Can you build an income portfolio without the income investing classics such as oil and tobacco producers? We think you certainly can. Even more importantly, if you want a sustainable long-term income, we think that you should. In our view, increased regulatory scrutiny and transition costs make oil and tobacco unappealing investments, and we see better opportunities for income growth elsewhere.

Our sustainability assessment is centred on a core question: is this investment compatible with a sustainable economy? We analyse all individual investments held in the Sustainable Income portfolio, from equities to emerging market bonds, infrastructure companies to investment grade bonds. While each asset class has its nuances, we take one consistent approach whereby the ESG analyst brings together the bottom-up work of our teams.

Why accepting investment risk makes sense

Creating a sustainable income stream remains one of the most common demands among individual investors. While higher interest rates on savings accounts might seem tempting, accepting investment risk is about reducing other risks, such as inflation and longevity risk. A well-considered long-term approach will pay dividends over time. We believe that our broad opportunity set, as well as the combination of skilful asset allocation and experience in stock picking, allows us to harness the best income payers of tomorrow to deliver real income, time after time.

 

Risk factors        

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions. This communication was produced and approved in July 2023 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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Author

Lucie Majstrova

Investment specialist

Lucie is a multi-asset and income product specialist in the Clients Department. She joined Baillie Gifford in 2021. Prior to this she spent 9 years at HSBC Private Banking where she focused on investment advice for private clients. Lucie has an MA in International Economics from IHEID in Geneva.

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