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Over the last 10 years the Aegon Diversified Monthly Income Fund has always evolved to meet the challenges and opportunities of the economic cycle. The availability of income today allows for asset allocation decisions that would have been unthinkable when rates were close to zero.
Evolving environment
Markets have been dominated in the last two years by the twin spectres of inflation (which peaked at 40-year highs) and rising interest rates (the 2-year move in UK base rates from just 0.1% in September 2021 to 5.25% in September 2023 is the sharpest increase since the late ‘80s). There have been widespread implications across asset classes but the dramatic re-set in bond prices is perhaps the most significant.
In our article, ‘The enduring case for multi-asset income’ we have reflected on the Fund’s ability to flex its asset allocation as markets have evolved in a higher interest rate environment. It is now time to elaborate on the phrase we used, that “the changing income environment allows for greater exposure to lower-yielding assets within the portfolio”.Income investors have had to work hard to capture an attractive level of income ever since the financial crisis of 2008/09. This was exacerbated by the final reduction in rates as Central Banks loosened policy further in response to the Coronavirus pandemic.
Evolving yields
By 30 September 2021, with interest rates still unchanged from their post-pandemic floor, global bond yields were low and credit spreads were at 14 year tights; indeed some $13.1trillion of global debt had a negative yield. Accordingly, the portfolio’s allocation to bonds (just c34% of NAV) and their contribution to its income generation were historically low. Figure 1 shows the 12-month forward yield which we forecast* from the fund’s portfolio at that date.
Figure 1: Projected 12 month portfolio yield as at 30 September 2021.
As at 30 September 2021. Fund shown: Aegon Diversified Monthly Income Fund.
*Projected yield is forecast by combining the contractual income our bond holdings will accrue over the following twelve months and the expected distributions of our equity instruments as measured by consensus market forecasts.
The combined forecast yield from that third of the portfolio was just 1.12%. Whilst this was clearly not helpful in the context of a 5% objective it was the right call and bonds did, of course, retain some merit for their relatively low volatility and diversification. It did, however, mean other allocations had to pick up the income strain: the two equity sleeves offered a combined 1.74% of prospective yield from c34% of the portfolio; the alternatives allocation (a near record high c31% of NAV in infrastructure, renewable energy asset and REITs) offered 1.4%.
Behind the asset class shifts there were other themes at play, for instance a bias away from US equities since that market is traditionally low yielding towards UK, European and Far Eastern markets where distributions are higher. Nonetheless the combined projected yield was still marginally less than our 5% objective.
Move forward over two years and the picture is materially different. Bonds offer over half of the fund’s significantly better projected yield with the biggest change in the Investment Grade sleeve whose allocation has grown from c5% to c18% of NAV; its 12bp projected contribution has grown to 110bp. Even cash now has something to offer.
Figure 2: Projected 12 month portfolio yield as at 25 February 2024
As at 25 February 2024. Fund shown: Aegon Diversified Monthly Income Fund.
Evolving portfolio
Bond yields at levels rarely seen since the financial crisis are clearly good news for the ready availability of income. But there is more to it in a multi asset context.
Dampening volatility – adding to bond allocations, particularly in IG as we have done, allows for lower volatility within the portfolio. When uncertainty remains significant and asset class correlations high, it is surely better to tilt towards the contractual income of bonds and their pull-to-par nature which aids total return.
Accessing growth – being less reliant on equities for income offers a chance to reshape that component of the portfolio by geography, industry and theme. Low average yield from the US equity market is no longer the issue it was. Instead, its growth potential is something than can more readily be tapped.
Similarly, growth themes in other markets are not off limits.
Some 7.9% of the portfolio (25% of our equities) is now invested (as at 25 February 2024) in eight businesses benefitting from the technology & AI theme which has been an important growth engine whilst other parts of the market have faltered. It would have been difficult to own companies like Microsoft (developing AI and holding a 49% stake in ChatGPT) and Broadcom (a global leader in semiconductors and infrastructure software) when income was scarce since they yield less than 1% and 2% respectively. Outside the US there are market-leading opportunities in related industries including integrated circuits (eg TSMC) and power for data centres (eg Schneider Electric) whose place in the portfolio is more assured when bonds shoulder the income burden.
Sector-wide valuations are always in mind and the current macro uncertainty still reinforces a bias towards quality but the opportunities represented here will, we believe, prove to be significant and enduring. They will change the way the world operates, and it is right to look to be invested.
Always evolving
Markets wax and wane with the economic cycle. Navigating that in real time is a key attribute of Aegon’s Diversified Monthly Income Fund, an actively-managed multi-asset fund with a bespoke portfolio that is unconstrained by benchmark.
The outlook is uncertain but the bond re-set of the last two years has thrown up some tremendous opportunities to rethink how we deliver strong risk-adjusted total return - a very attractive income with new opportunities for growth.
For Professional Clients only and not to be distributed to or relied upon by retail clients.
The principal risk of this product is the loss of capital. Please refer to the KIID and/or prospectus or offering documents for details of all relevant risks. For all documents please see www.aegonam.com/documents.
Past performance does not predict future returns. Outcomes, including the payment of income, are not guaranteed.
Opinions and/or example trades/securities represent our understanding of markets both current and historical and are used to promote Aegon Asset Management's investment management capabilities: they are not investment recommendations, research or advice. Sources used are deemed reliable by Aegon Asset Management at the time of writing. Please note that this marketing is not prepared in accordance with legal requirements designed to promote the independence of investment research, and is not subject to any prohibition on dealing by Aegon Asset Management or its employees ahead of its publication.
Fund Charges are taken from capital, increasing distributions but constraining capital growth.
Income is not guaranteed and 5% is a target yield, being the fund's target total distribution over the next 12 months as a percentage of the current mid-market share price. The target yield may be revised in future.
All data is sourced to Aegon Asset Management UK plc unless otherwise stated. The document is accurate at the time of writing but is subject to change without notice.
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Aegon Asset Management UK plc is authorised and regulated by the Financial Conduct Authority.
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More about the authors
Vincent McEntegartInvestment Manager
Vincent McEntegart, investment manager, is a member of the multi-asset group. He is co-manager of the Diversified Income strategies. Prior to joining Aegon AM, Vincent worked for Goodhart Partners (an MBO of the multi-manager business of WestLB Mellon Asset Management) where he was a partner responsible for client relationships and new business.
