Investment Adviser - Demographics and the demand for equity income
22 January 2010
This article discusses the interaction of demographic developments in the United Kingdom and the demand for equity income investments. In mid 2008 around one fifth of the UK’s population of 61.4 million was of retirement age, women over 60 and men over 65. By 2033 the proportion of both genders aged over 65, to take into account changes in pensionable age, is projected to increase from 16% to 23%, reflecting the ageing of the ‘baby-boomer’ generation born in the 1960s (Chart 1). The increasing post-retirement population affects both the investment menu and risk appetite in ways that have been well chronicled. Tracking the progress of the baby boomers in the US suggests that while in affluent middle age during the 1980s and 1990s, this group concentrated on accumulating wealth, investing heavily in property and equity markets and boosting asset prices. Since the turn of the century, impending retirement has prompted a switch in asset allocations away from equities towards bonds. This mirrors asset allocation patterns in pension funds, where money is traditionally moved from riskier (equity) investments to less risky instruments (bonds or cash) as active members approach retirement. However, recent changes to the investment environment and perceptions of risk have caused investors to reassess the pattern.
Official interest rate policy in the aftermath of the global financial crisis and severe recession is to maintain low interest rates for as long as necessary to ensure survival and promote recovery. The yield available from cash or government bonds is therefore relatively limited and has led investors to look for income from a range of asset classes. Low interest rates in aging societies accelerate the existing tendency towards (private sector) dis-saving amongst the elderly as they try to support extended consumption over longer life spans. For younger age groups this example should serve to encourage more saving and investment. The wide gap between the dividend yield and cash rates makes equity income an attractive option (chart 2). Dividends make up the bulk of total equity returns in the UK – more than 100% of the total return in the last decade and 72% over the past 30 years. The dividend cuts that featured last year as non-financial companies focused on maintaining cash reserves in a difficult economic environment are less of a concern as credit conditions continue to ease, although the dividend stream from the financial sector may take longer to recover.
The impact of the global financial crisis on the accumulated wealth of, and income available in retirement to, the baby boomers may have caused a number of people to work longer and/or extend the accumulation phase as they seek to recoup some of their losses and secure higher levels of retirement income. Recent history has also raised awareness of a number of investment, economic and policy risks. One lesson is the need for investors to diversify their sources of income from cash and government bonds to include others such as corporate bonds, equity income and property income. Another is that low interest rates do not mean that inflation will remain low and relatively stable. Therefore, there has been a switch of emphasis from nominal to real returns against a backdrop where governments are massively expanding their balance sheets and deficits are also likely to grow on the back of demographic drivers such as increased pension and healthcare spending. Equities are perceived as offering something of a buffer against inflation compared to cash or conventional gilts. Equity income is also an attractive alternative to government paper for those concerned about policy risks. All in all, demographic trends and investment theory suggest investors should assess the opportunities in equity income.
Frances Hudson, Global Thematic Strategist, Standard Life Investments
This article was first published in Investment Adviser on Monday 1st February 2010.
