The best income opportunities right now

Fidelity Multi-Asset Income manager Talib Sheikh tells ii’s Sam Benstead how he is investing for income today. This includes opportunities in equities, bonds and alternatives.

Sheikh also gives insights on how the economic backdrop impacts income investors, including what higher interest rates and inflation mean for generating a return. He also explains how his portfolio offers a competitive alternative to high cash rates available from banks and money market funds.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider interview. Our guest today is Talib Sheikh, a multi-asset portfolio manager at Fidelity International. Talib, thank you very much for coming in.

Talib Sheikh, multi-asset portfolio manager at Fidelity International: I think it’s a little bit different to single asset class fund managers. I kind of describe my job as a little bit like being a chef. What we do is we look at the range of asset classes that we have on our platform, and think about how we might want to blend them together. But most importantly, we need to think about what the end investment problem is that we're trying to solve. My job, really, is to focus on generating a repeatable level of income, blending those asset classes together to make sure that they work together to achieve that objective.

Sam Benstead: Income is one of the areas you specialise in. So, where are you finding the best income opportunities today?

Talib Sheikh: It’s a difficult time to be an income investor because we all know that interest rates, compared to the era that we saw post the great financial crisis, have moved much higher. So, the cash available on deposit at the bank, and the cash available in government bonds at these levels looks really quite attractive.

But I do think we need to take a step back and think; why are interest rates higher today than they were 10 years ago? And the reality is that inflation has fallen, but it’s still much higher than it has been historically.

We think we’re in a new regime where interest rates are higher, inflation is likely to be higher, and having a more diversified multi-asset income process can add real value to clients. Maybe not for today, but certainly over the coming months and years.

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Sam Benstead: So, cash is the big competition for you then. You can get about 5% at the moment in money market funds. So, where are you investing to provide investors with a more attractive or more consistent income stream? And how much are your portfolios yielding at the moment?

Talib Sheikh: You’re right. Cash has really been king over the last couple of years. And as we look into money market funds or even cash on deposit at banks, it’s grown hugely since the pandemic. Certainly, when we look across a more diversified universe, we’re finding interesting opportunities.

When I look at the UK funds that I look after, we're currently distributing around 6%, so ahead of cash. But clearly, we are taking more risk than cash. We would hope that that will be sustainable over the coming months and years. And if we think that the Bank of England has already cut once, we expect them to continue to cut. So, cash rates which are available today are unlikely to persist.

Sam Benstead: And that 6%, where is the growth in that income? Where are the drivers there for you? Are you looking at stocks, bonds, alternatives?

Talib Sheikh: We really think about each asset in our portfolio as having a slightly different role. We have what we call “core yields”. So, these are typically fixed-income orientated investments which are there to grind away to give the bulk of that yield.

We also want to have what we call “growing yields”. And, again, these are typically associated with equity-type investment. So, we’re not looking for the highest dividend-yielding stocks globally. What we are looking for is dividends that can grow through time and give the potential for some capital growth.

Finally, we want to have what we call “alternative yields”. We want to look at things that might be quite hard for the end investor to go and get themselves that actually give us something different, something diversifying. My job is to think about how we blend those together, so we can give a repeatable level of income within that medium-risk framework.

Sam Benstead: So, let’s dig into the portfolio then. In the equity space, what do you look for in terms of an income share?

Talib Sheikh: I don’t pick the actual equity shares which go into the portfolio. The beauty of being at Fidelity International is that we have a wide range of analysts and fund managers that we can partner with. So, we’re going to partner with our equity-orientated fund managers and speak to them about where they are finding the most attractive dividend yields.

There’s been a lot said about technology. There’s been a lot said about the “Magnificent Seven”. And many of those dividend-yielding stocks have relatively underperformed the market. We actually think that that’s about to change. The amount of dividends equity markets are paying at the moment is at an all-time high, even as those stocks have lagged the broad index. And we think that’s a pretty good set up for equity income at this moment.

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Sam Benstead: Inside equities, where are you finding the best income opportunities today?

Talib Sheikh: One of the areas where we are quite overweight is financials. Banks really have transformed since the great financial crisis. In many ways, regulators have turned them into quasi-utilities and allow them to return that capital to shareholders. So, when I look at the sector overweight that we have in our portfolio, certainly financials is something that we find quite attractive on a global basis.

Sam Benstead: Fixed income is an important area for income since interest rates have risen. But where are you finding the most attractive bonds?

Talib Sheikh: I think you have to break the yields available for fixed income into two parts. The first part is the core interest rate, the interest rate which the government in that country pays on their government debt. Clearly, those have moved up since the great financial crisis, and we think there are some opportunities there.

The other part of that interest rate is what we call the spread. So, that is the premium received on top for lending to a corporate or lending to a company. And those spreads are relatively tight at the moment. So, when we look at things like investment-grade credit, and the highest-quality bonds, we would argue that there’s really not much risk premium there, and we’re relatively underweight.

When we look at more risky bonds, high-yield bonds or junk bonds, we find that there’s some more interesting opportunities. But we would argue that they’re expensive and unlikely to give capital returns from here. The places that we find more interesting are some of the government bond markets.

Sam Benstead: And what about alternative income sources? So, stocks and bonds are the key building blocks of a multi-asset portfolio. But there are other opportunities out there as well, aren’t there?

Talib Sheikh: Absolutely. The portfolio has had some exposure to some of the UK-listed investment trusts, particularly those associated with green power generation, which I think offer high levels of cash flow and yields which are linked to inflation through time. They’ve clearly had a bit of a rough ride this year, but we think that the worst is behind us.

But we also look at things like structured credit. So, these are private credit markets where we’re partnering with our fixed-income department again to give investment-grade yield with very little interest-rate sensitivity, which we think is very attractive and very safe.

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Sam Benstead: And what’s the split at the moment in your portfolio between stocks, bonds and alternatives? And is that a normal environment at the moment for you?

Talib Sheikh: It depends on the portfolio, but typically around 50% of the portfolio is in fixed income. Those core yield-type investments. Again 30% to 40% is associated with equity-oriented investments, those growing investments, and then the remainder in alternatives.

We tend to be more opportunistic in alternatives. There are some interesting opportunities, [such as] private structured credit that I just talked about. But, really, at the moment we are waiting for more opportunistic moments.

Sam Benstead: One of the highest-yielding bond areas tends to be emerging market debt. Is that an area you like at the moment?

Talib Sheikh: We have some selective exposure, but it’s on a country-specific basis. And, really, we like the interest-rate exposure rather than the currency exposure. And that's because we think that the dollar remains relatively strong. When we look across the globe, we still see a kind of US exceptionalism in terms of growth. We think that probably means the dollar remains quite strong, and that tends to be a headwind for those types of investments. But you’re right. The real yields, the interest rates which are available, are attractive. And certainly that's something where we would look, I can envisage over the next year or so, to try and build out some of that exposure.

Sam Benstead: Talib, thanks very much for coming into the studio.

Talib Sheikh: Great. Thank you.

Sam Benstead: And that’s all we’ve got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.