In other words, income probably warrants more attention, including from allocators not focused on seeking income. And as noted earlier, income may play a key role in meeting a variety of investment objectives, such as paying liabilities and improving tax efficiency. But it’s important to be aware of the trade-offs that can be introduced when focusing on income or seeking to generate more of it. Below we highlight the need for a balanced approach when pursuing income in multi-asset portfolios, given the potential trade-offs between income and capital return, risk and portfolio diversification.
Trade-off 1: Income vs capital return
Total return is a combination of capital return (the growth of the capital invested) and income return (the interest received on that capital). Looking across asset classes, the relationship between capital return and income return generally changes as the level of income changes. In short, generating higher income in multi-asset portfolios tends to come at the expense of capital return. This does not mean that total return decreases, but rather that the mix of capital and income returns changes.
We examined these dynamics for a variety of asset classes since 1995. As shown in Figure 3, we didn’t find a clear relationship between income and total return. Moving into asset classes with higher income didn’t change the total return expectation; i.e., there was no trade-off between income and total return.
Figure 4 shows why this was the case. In asset classes with higher income, capital returns were lower. Generating more income essentially meant shifting some of the expected return to income while keeping the total return relatively consistent.