2020 was a tough year for income investors.
Around the world, record low interest rates and quantitative easing have led to low bond yields, while equity dividends have been slashed and often suspended.
As we look across markets now, the classic portfolio mix is not only challenged on the equity side, but also on the fixed income side.
Low bond yields mean very little income from bonds, making diversification the only real reason to own sovereigns.
Bond yields can go lower still, but as this year is looking like the start of the next economic cycle, we may see a gradual rise in yields despite central bank policies that are aimed at keeping yields low.
Opportunities exist across credit markets and advisers and their clients need to be selective.
Credit spreads have tightened as the market rallied from the lows seen in March 2020.
The shorter durations and higher yields mean sub-investment grade bonds are more attractive from an income perspective than investment grade bonds. And if bond yields rise this year, investment grade bonds will be more impacted than high yield bonds.
The extra yield from corporate credits, and sub-investment grade in particular, is welcome but credit risk shouldn't be ignored. Be wary of the highest yielding credits rated 'CCC', where a double digit yield may be an offer you should refuse.
One area of the credit markets we've been buying is Additional Tier 1 (AT1) bonds. Issued by banks, they fall below traditional bonds in the capital structure, so are therefore higher risk.
While AT1 bonds have delivered high yields and attractive total returns, banks have had to suspend paying dividends to shareholders and share prices have fallen consistently in recent years.
The excess return from owning the bonds rather than the shares has been remarkable.
Looking forward, bank equity returns may start to catch up. Bank shares are cheap, earnings are improving despite low interest rates, and dividends may restart this year.
Elsewhere, listed infrastructure has been impacted by the global shutdown.
Previously secure demand-sensitive income streams from airports and toll roads were major losers in 2020, as that security was called into question.
While they will recover as mobility recovers, higher risk premia are justified now.
On the positive side, there are a number of sustainable growth opportunities in the regulated utilities sector.
The growth in demand for electricity generation from renewable sources has accelerated in recent years, and this is changing the outlook for this often overlooked sector.
The issue of property
Listed real estate also performed poorly last year.
High street retail was challenged even before Covid, and the challenges are greater now.
Hotels and offices were the big negative surprises of 2020, and while holidaymakers may return, business travel may take some years to reach pre-Covid levels.
With millions now expecting to work from home for at least some of the working week, office rents also look to have a less attractive growth trajectory.
But the picture is not all bleak for real estate.
Data warehouses have provided secure and growing income streams, benefitting from the growth of the technology sector during lockdowns.
The same is true of logistics, as online retailers are renting more warehouse space. What's more, the defensive characteristics of the private rental sector have made it too a safe haven during these uncertain times.
There are opportunities for clients seeking income from capital markets.
But we have to accept volatility, and more than we have previously.
The good news is we are approaching a stage in the cycle that should support risk taking. Decide what you want to own on behalf of your clients, and add risk gradually in these markets.