Income from your

Portfolio - Bond and Dividend Yields

May 2015


Trust Management continually evaluates the way in which we manage our clients' assets and we are always striving to deliver investment products and services focused on the needs of charities.


To this end, we have been conducting extensive research and modelling on an alternative management style for New Zealand Bonds, a management style that focuses on the generation of income.


For almost all of the last 50 years, an investment rule of thumb has been that fixed interest investment is synonymous with income, and investing in shares equates with capital growth.


That isn’t surprising given that, almost throughout the 1958-2008 period, the dividend yield on shares in developed markets was lower - generally by a wide margin - than the yield on long term fixed interest securities.
















Click image to enlarge

This can be seen in the chart above, which shows the history - from 1871 - of the US 10 year bond yield and the US share market dividend yield.


The ‘recent’ 50+ year period on the right hand side (where the blue line lies above the red line) shows, for example, that in 1991 the dividend yield of the US share market - as represented by the S&P500 Index - was 3% when the 10 year Treasury yield was 7%. [1]


Grant Hope

Chief Executive Officer

09 550 4044





Shane Coward

General Manager

09 550 4045




John Williams

Investment Manager

09 550 4046




It has therefore become almost second nature to assume a (starting) dividend yield for shares below the long-term fixed interest yield.Naturally, over the past few decades investors haven’t placed much emphasis on buying shares for income. Rather, investing in shares over a short period has been justified by an expectation of capital gain.A big change has taken place in the last four or five yearsSince late 2010, the fall in long term bond yields has accelerated to the point where they are now close to record lows - and are now below the dividend yield on shares.As at 6 May 2015 the dividend yield in all the major share markets except the US was higher than the corresponding 10 year sovereign bond yield (the US dividend yield is marginally below). This is also the case in New Zealand and Australia.


New environment, new investment challenges

This new relationship poses a challenge for all investors, particularly fiduciaries with an investment objective of making distributions to beneficiaries.


We tend to view fixed interest investments as low risk with small capital movements, but generating good income. In contrast, we see shares as high risk, with potentially large capital movements, but offering low income.


Although the risk and capital movement features are unchanged - these are inherent in the nature of fixed interest and shares - the income relationship is no longer the same. A higher income can now be generated by investing in shares rather than fixed interest and cash.


Time to review portfolios?

In view of this, investors with a focus on income, and whose financial position is strong enough to withstand some loss of capital, may be tempted to shift their portfolio weightings away from fixed interest and towards a higher allocation to shares.  Certain areas of the property market also hold considerable appeal for their attractive income component. Such investors should consider reviewing their long term capital market assumptions across all asset classes and their expectations for the income and capital components of future returns.


In most cases this will not lead to any change to the strategic asset allocation given that the relationships between fixed interest, property and shares – in terms of their long term expected returns, volatilities and correlations – is unlikely to have changed. (In this context it is worth observing the historical difference in volatility between shares and fixed interest – see Figure 1. Although the difference in volatility has narrowed in recent years, it remains significant).


However it should temper expectations about future returns and in particular the income that the portfolio is likely to generate.


Figure 1: Volatility of Shares and Bonds*
























*Rolling 3 year standard deviation of monthly returns annualised, ended the dates shown



No silver bullet

There is no silver bullet to increase a portfolio’s income given the current low interest rate environment.

While it may be tempting to move up the risk curve by tilting the portfolio towards higher yielding credit, or by increasing the allocation to shares and/or property, before contemplating any such moves, investors should carefully consider all their investment objectives, particularly their risk tolerance.


Working with you to review your investment portfolio

Trust Management works closely with clients to match their appetite for risk and need for income within a long term investment strategy.

Given the changing income relationship between fixed interest and shares, we would welcome the opportunity to help you review your portfolio and discuss what the evolving investment market means for you and your trust.


If you have any questions, or would like to know more, please do not hesitate to contact John Williams, Investment Manager on 09 550 4046.


[1] It is interesting to ponder whether the “new” bond yield - dividend yield relationship represents a return to the norm - with the ‘recent’ 50 year period an aberration - or whether this “new” relationship is abnormal. In 1958 investors were surprised to see dividend yields fall below long term bond yields. In contrast the market today looks to have taken the new “dividend yield higher than bond yield” relationship in its stride.

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