Sustainable Income – Built to last : How to give DC savers the income they need for a comfortable retirement?

By Lucie Majstrova, Investment Specialist, Baillie Gifford

Today’s retirees need to set themselves up for the long term. Indeed, women reaching the state retirement age this year can expect to spend over twenty years in retirement. What does it mean for Generation DC? How can you balance between drawing the highest possible income today without jeopardising your long-term plans?

Our Sustainable Income portfolio was set up to answer this challenge. To us, sustainable income means an income that grows with inflation over time. We aim to produce that by investing globally across nine different asset classes, in companies and countries that we believe are adapting to the world’s challenges to be the best income payers of tomorrow.

Income for the long haul

How can we generate income that can be relied upon for decades? We believe focusing on long-term income growth is the answer. Investing in a variety of asset classes allows us to match their different characteristics so we can deliver a resilient income today and grow it over time. Thanks to increased interest rates, fixed income, in general, offers more attractive income levels. Our global reach allows us to look beyond traditional fixed income asset classes, benefiting from higher yields on offer.

When it comes to stable, inflation matching income growth, we look to real asset classes: infrastructure and property. Our infrastructure investments were very valuable last year, delivering diversification benefits at a time when both equities and fixed income struggled. The income resilience that is often coupled with contractual linkage to inflation is a great match for our objectives, so while we have taken some profit since last year, it remains a key part of our strategy.

Last but not least, the engine of real income growth is equities. That is, if you pick the right ones.

Long-term income, not short-term yield

To fully reap the benefits of our broad opportunity set, we invest in a bespoke portfolio of hand-picked investments within each asset class. We test them for resilience and their potential to be the best income payers of tomorrow.

When the objective is finding income that can last for decades, it’s crucial to think about an investment’s potential five or ten years from now. While that may sound obvious, fascination with yield leads many ‘income’ investors to focus on this year’s dividend and coupon payments. They often take on significant risks to both income and capital in the process.

That’s why we focus on how a company’s dividend will progress over a longer period. Take the Danish pharmaceutical company Novo Nordisk, a holding since inception in August 2018. With a low current dividend yield, most income investors would give it a miss. However, since 2018 the company has grown its dividend by over 40 per cent and enjoyed significant capital growth – this is exactly the type of income investment we look out for. The trajectory of its dividend potential remains as exciting as ever, which is why it is still among our largest equity holdings.

Fit for The Future

Sustainability has two meanings: Will an investment’s income stream prove to be sustainable over long periods of time? And is it sustainable from ESG perspective? We believe the two are inextricably linked. The best income payers of tomorrow will be forward-thinking companies that are successfully adapting to meet the needs of a sustainable economy.

Can you build an income portfolio without the income investing classics such as oil and tobacco producers? We think you certainly can. Even more importantly, if you want a sustainable long-term income, we think that you should. In our view, increased regulatory scrutiny and transition costs make oil and tobacco unappealing investments, and we see better opportunities for income growth elsewhere.

Our sustainability assessment is centred on a core question: is this investment compatible with a sustainable economy? We analyse all individual investments held in the Sustainable Income portfolio, from equities to emerging market bonds. While each asset class has its nuances, we take one consistent approach.

Why accepting investment risk makes sense

The need to create a sustainable retirement income stream becomes more urgent as Generation DC is entering decumulation. Income investing is about reducing inflation and sequencing risk, and retaining flexibility. We believe that our broad opportunity set, as well as the combination of skilful asset allocation and experience in stock picking, allows us to harness the best income payers of tomorrow to deliver real income, time after time.

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Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority. Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs. All data is sourced from Baillie Gifford & Co unless otherwise stated. As with any investment, capital is at risk. Past performance is not a guide to future returns This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.