Cash – or multi asset income?

How can advisers address clients’ behavioural biases when it comes to determining the best ways for them to put their money to work?

Not very long ago, anyone looking for natural income had to take on risk to be able to get low single digit yields. Today this has all changed. With the Bank of England’s (BoE) base rate now at 5.25%, and with cash deposits and ISAs offering more than 4%, many income investors’ risk appetite has dwindled and they are questioning the need to invest in income funds when they could realise a similar return from cash.

On the face of it, they are completely right. At the end of April 2024, the average 12-month yield of monthly paying income funds in the IA 20-60 sector was 4.39%, where, according to the BoE, the average 1-year fixed term ISA was offering 4.57%. A better rate, coupled with lower to no risk, could push investors to the assumption that income funds aren’t really cut out for a high interest rate world – not unless their yield far exceeds what cash is offering.

However, are behavioural biases – where human emotion shapes investment behaviours – playing a part in investors’ current viewpoint? Before we explore this subject further, it is first important to highlight that there are scenarios where investing in cash in preference to natural income funds most certainly makes sense, including:

• Clients with no risk appetite
• Clients with a short-term horizon where the capital invested is needed.
• Those who may be looking to bridge the gap between work and retirement, where their currently capital is adequate, but they may just need the interest rate difference to cover them before they go into full drawdown.

Nonetheless, for the majority, is there truly a reason to invest in cash over something like natural income? If your client’s view is still yes, it may be useful to consider whether or not behavioural biases might be playing a part.

Anchoring and framing bias

It can always be difficult to value the unknown or compare how something has performed (hence the existence of benchmarks and sectors). This can be a very sensible thing to do; indeed, this is commonplace in finance: the risk-free rate. This is the ‘anchor’ which we use to determine whether the returns are worth the added level of risk. Anchoring bias is when we end up relying too heavily on that number and no longer look at newer information objectively. Framing bias is when a decision is made based on the way the information was given.

How does this relate to investing in either cash or natural income? As mentioned, there are many situations in which cash would be the better choice for the investor and there are many reasons why natural income would be the better choice. However, when investors experience both the anchoring and the framing bias simultaneously, the logic breaks down.

It can be very difficult for an adviser to recommend something with a yield lower than the investor’s default ‘anchor’ rate and framed in a way where the yield is the main point of comparison. Throw in a touch of confirmation bias (favouring information that confirms your current belief) and status quo bias (a preference not to ‘rock the boat’ and to stick to inaction) and suddenly natural income is the lesser choice, no matter the investor’s circumstances.

There are positives to having a baseline figure, and to framing a choice in the best possible light; simply knowing the potential biases can sometimes help an investor in making a rational decision, and the adviser to guide them. The key is for the adviser to be aware of these biases – and where possible explain how investing for natural income can be advantageous. For example (and this is explored in more detail below) the potential for the growth of capital, and diversification.

Case study: WS Canlife Diversified Monthly Income Fund

At the start of May 2024 gilts were yielding over 4% and interest on cash was over 5% (albeit accessing that rate for retail investors is challenging). The WS Canlife Diversified Monthly Income Fund, meanwhile, yields 4.5%.

The attractions of a risk-free 4.5% are clear – but the risk of holding risk-free is that of missing out on capital gains. The WS Canlife Diversified Monthly Income Fund holds a wide mix of assets, meaning that capital risk is spread across the portfolio.

Nearly all the overseas investment grade bonds held in the portfolio are trading at discounts to their face value, implying a capital gain, as well as the coupon as those discounts unwind to maturity. This is also true of many of the fund’s sterling fixed income holdings. Almost 7% of the fund is invested into high yield bonds, providing another potential source of income.

With the fixed income portfolio showing attractive yields and, in the absence of defaults, embedding capital gains into future returns, the equity portfolio has the capacity to hold some high-growth positions. This is likely to help inflation-proof fund returns. Well-known technology names such as Microsoft, ASML and TSMC feature, but also less well-known names such as Cadence Design Systems, which is involved in the design of complex chips.

Keeping the fund diversified, exposure to growth comes from other directions too, such as LVMH, the luxury goods company, and Amgen, the US biotechnology medicines company. Revenue at Amgen is forecast to grow from $25bn in 2020 to $35bn by the end of 2025, pushing adjusted earnings from $12 to $21 per share over the five years. The return versus cash (using the WS Canlife Sterling Liquidity Fund as a proxy for cash) can be seen below.

The WS Canlife Diversified Monthly Income Fund has a historic rolling yield of 4.3%, with an indicated minimum monthly yield on the current unit price of 0.33%. The fund has easily kept pace with the yield on cash over the past nine months when interest rates were high (see chart below – the WS Canlife Sterling Liquidity Fund is used as a proxy for cash).

Source: Morningstar, bid to bid, with income re-invested for C share class to 31/03/2024

Important information

The value of investments may fall as well as rise and investors may not get back the amount invested.

The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.

The fund may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the fund. The value of the property is based on the opinion of a valuer and is therefore subjective.

Canada Life Asset Management is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Promotion approved 23/05/24