Many Australian investors continue to focus on income-generating investments. However, with ongoing market volatility, it’s worth thinking carefully about how income-generating investments are allocated within a portfolio.
The search for reliable, risk-adjusted income remains a prominent theme in Australian investing, partly driven by an ageing population and the growing number of Australians transitioning to retirement and looking to fund their lifestyle without relying on employment income.
Australia’s superannuation system is also entering a significant transition. The Australian Government estimates that more than 2.5 million Australians will retire over the next decade, significantly increasing the number of people drawing down on their superannuation. While considerable attention has traditionally been given to accumulating superannuation, there is now an increasing focus on how those savings can be effectively used throughout retirement.
Income-targeted investments can play an important role in achieving these goals; however, not all income investments are the same in terms of risk, liquidity and regularity of returns. As an investor, it’s worth considering what you want to achieve from the income portion of your portfolio and the role diversification can play, particularly when periods of market volatility arise.
Investor preference is often to look to the domestic share market for the income-producing portion of a portfolio. While the Australian market is rich in dividend-paying companies, particularly in sectors such as banking, mining and telecommunications, greater diversification within the income component of a portfolio can also play an important role. While yield is an important consideration for those seeking income, particularly when transitioning to or living in retirement, so too is the stability of the underlying capital.
Periods of volatility in public markets can significantly affect investors’ capital when seeking income through equities. When money is invested in listed markets, the value of that capital is subject to market fluctuations, while dividend income can also vary according to company performance and economic conditions.
That’s not to say public markets should be avoided, but rather that allocating some of the income component of a portfolio to income generating investments in other markets may be worth considering.
Private markets are generally less liquid than public markets and are not subject to the same daily market pricing. For investors comfortable with the associated liquidity constraints and risks, this can mean less observable short-term volatility than is typically experienced in listed markets.
Allocating part of an income portfolio to income-producing private markets may therefore provide another source of regular income and diversification. However, investors should consider the underlying assets, credit risk, liquidity arrangements and investment structure rather than viewing capital stability or income as guaranteed.
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When it comes to generating income from private credit, there are a few key points for investors to consider.
For a start, it is important to be clear about the role an investment is intended to play within a portfolio. Seeking progressively higher yields can involve accepting additional credit, liquidity or concentration risk, so headline yield should not be considered in isolation.
For investors looking to private credit to generate an income stream, it is important to understand whether the underlying assets themselves produce an identifiable and regular source of income. Investors should be clear about how the loan or fund generates its returns and how frequently income is expected to be paid.
When the underlying security is property, examples can include existing residential or commercial mortgages, where borrowers have committed to regular loan repayments. Alternatively, the underlying investment might generate regular income through assets such as an office building, shopping centre or a hotel.
However, if the underlying security property is in the process of being developed, it is less likely to be producing income at that time. Again, this is not to suggest that investment in development assets should be avoided, but rather that the risk and return characteristics may differ from investments specifically designed to generate regular income.
Of course, there are inherent risks in any kind of investment, whether in public or private markets.
Having a diversified portfolio of loans underlying an investment can help mitigate the potential loss of income and capital associated with individual borrowers or assets. If investors are relying on an income stream from one large asset, they may be exposed to concentration risk should that particular asset come under stress or market conditions change.
Another important consideration is the track record and quality of the investment manager. Investors should consider factors such as the manager’s experience, underwriting standards, approach to risk management, diversification, valuation practices and the performance of the underlying assets.
Thinktank works with major institutions, including global and domestic banks and credit funds, to provide finance to borrowers and has established substantial institutional funding relationships over its 20 years of operation. Throughout that period, Thinktank has never missed a scheduled interest or principal payment to its funders or investors.
Australia’s focus on investment income is likely to continue growing as more Australians move into retirement. But rather than focusing solely on headline yield, investors should consider the underlying assets, risks, diversification and reliability of the income stream when planning how income-generating investments fit within their broader portfolio.
The Trust invests in domestic commercial and residential Mortgage Backed Securities (For Wholesale Investors Only)
Thinktank Income Trust offers investors first mortgage exposure to domestic, established commercial and residential property (for Wholesale Investors only)
Disclaimer: This article is prepared by Lauren Ryan at ThinkTank. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.
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