Multi-Asset Income Funds: What Comes with the Extra Income?

Kate Lin: Welcome to Morningstar. Rising interest rates raise cash yield expectations. Moreover, income-generating multi-asset income funds that have been popular in an extended low-yield environment are facing growing competition from bank deposits and money market funds, for example. For income seekers, are multi-asset income funds still relevant?

Bryan Cheung, an associate director for Morningstar's manager research team, is with us today. He has recently written a research paper about these funds.

Hi, Bryan. Investors have been buying in cash-like instruments like money market funds are receiving strong inflows. In comparison, are multi-asset income funds still relevant for income-seeking investors?

Bryan Cheung: Hi, Kate. Yeah, thanks for the question. So, the short answer is yes, but let me elaborate. So, first of all, investors must carefully consider the trade-offs of these short-dated instruments like time deposits and also money market funds, because one, their yields can actually fluctuate. For example, during rate cuts in economic downturn, their yields tends to fall. And second, because they don't have capital upside potential, they have a dismal chance to beat inflation in the long run. So, now, we think multi-asset income funds are still relevant because their long-term investment prospects have actually improved, because now they are enjoying a more attractive opportunity set underpinned by improved yields and diversification benefit offered by fixed income assets. And the multi-asset income funds can achieve a better yield without taking on excessive risk today.

Lin: So, you mentioned better opportunity set and the bond outlook has been much brighter than before. What have multi-asset income funds been doing to capture that and what will be the impact on dividends?

Cheung: Yeah, we looked at the multi-asset income funds available for sale in major Asian markets like Hong Kong and Singapore. So, on average, since the start of 2022, we have observed a higher distribution yield and also a high allocation to investment grade bonds and meanwhile, a lower allocation to equity and also high-yield credits. And this actually reversed the downtrend that we saw from 2020 to 2021, where we saw the yields and spreads compress to historical lows following the rate cuts by central banks during the coronavirus outbreak.

Overall, I think now the multi-asset income funds, they don't need to stretch as much as the last few years to generate a decent income, and they can also more easily achieve better risk-reward. For some of the major global multi-asset income managers that our analysts covered, we saw that they have indeed been taking advantage of the higher yields offered by defensive assets by reallocating from the riskier assets like equities and high-yield credits in order to optimize the risk-reward considering the higher recession risk and meanwhile, they don't have to sacrifice the payout.

Lin: So, let's go into individual funds that you studied like Allianz Income and Growth Fund. What should investors watch out for?

Cheung: Yeah, thanks Kate. So, in Asia, investors seem to be attracted to multi-asset income funds with the highest but durable payouts, and Allianz Income and Growth is one of the examples and also is one of the most popular funds in the region.

So, this fund has a distribution yield of 9% per annum, and we think it's hard to sustain because it's highly dependent on short-term capital gains which is quite unpredictable. This heightens the risk of capital erosion in volatile markets, which can reduce the fund's capital base and limits its capacity to provide a stable income. And in fact, it most recently reduced its monthly distribution in April this year and it's the fourth reduction since 2016. Also, the fund has a high downside risk because it concentrates in three highly correlated assets which are U.S. growth tilted equities, convertible bonds and high-yield credits. For example, in 2022, it suffered a loss of around 20% which is quite high for a multi-asset income fund. And this is something that investors often overlook when markets are doing well. And we think it's paramount to consider why a fund's payout is realistic and maintainable and to balance among yields, risk and returns, because we know yields doesn't equal returns and we have seen many higher-paying funds having poorer returns and bigger NAV declines than peers with lower payout.

And last but not least, investors need to bear in mind that multi-asset income funds aren't homogeneous. They can vary in terms of payout, geography and also risk, and investors must select a fund that matches their investment objectives and risk tolerance. And it is equally important to select managers who are prudent with their payouts to safeguard investors' long-term outcome and have proven their flexibility in adjusting their portfolios through changing market conditions.

Lin: Thank you so much, Bryan. For more information, check out the full report that you will find a link below. For Morningstar, I'm Kate Lin.