If income were auditioning for a role in a portfolio, it might be considered a triple threat. No, not in its ability to act, sing or dance, but in its potential to deliver three key benefits: a regular cash flow, tax advantages and return consistency.
The last of these is often underappreciated, especially by investors focused on capital appreciation. Our research suggests, however, that income can contribute more than half the returns for a standard 60% equity/40% bond portfolio over a five-year investment horizon. This percentage increases for asset classes with a higher income profile1.
The case for income is particularly pertinent now. With cash rates at around 5%, the world of income has changed, and relatively high levels of income can be achieved without taking as much risk as in the past. This should prompt investors to take a fresh look across asset classes to see where potential opportunities lie. For example, should investors look to increase the income target in their equity allocation or in their credit allocation?
To determine the right answer for their portfolios, we believe investors need to understand how much potential income a given asset class can generate relative to the level of risk introduced. We suggest that investors use a framework, such as our cross-asset risk and relative yield or CARRY landscape (Figure 1).
The CARRY landscape uses the primary risks of each asset class in order to plot the current income level in exchange for taking low risk (green), medium risk (yellow) and high risk (red). This can help investors weigh opportunities against risks.