Where to find income now interest rates are falling

Fidelity Multi-Asset Income manager Talib Sheikh tells ii’s Sam Benstead how he is investing for income today. 

He shares his views on government debt, revealing what he thinks is the sweet spot for bond maturity length, as interest rates come down around the world.  

Sheikh also speaks about the new Labour government in the UK and the impact they will have on asset prices, as well as what a higher inflationary environment means for investors.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider interview. Our guest today is Talib Sheikh, a multi-asset portfolio manager at Fidelity International. Talib, thank you very much for coming in.

Talib Sheikh, multi-asset portfolio manager at Fidelity International: It's great to be here.

Sam Benstead: Today's economy offers up lots of challenges for investors. We've had an inflationary spike, we've had rising interest rates, now interest rates have begun to fall. So, just how difficult is it to invest in this environment when you want to generate income?

Talib Sheikh: I always say when a fund manager says it's more uncertain today than it's ever been, I always push back on that. I would say it's always uncertain. We never know what the future is, and our process really is built around probing into that macro uncertainty, trying to find out what the next phases of the economy are likely to be, and how we can position our clients’ capital ahead of that.

At the moment, we would expect that interest rates are likely to fall over the coming years. I don't expect them to go back to the zero-interest rate environment that we saw post the great financial crisis. I also think that business cycles have become more de-synchronised. So, if we think back to where we've been over the last year or so, the Chinese economy has been terrible. The US economy has done quite well. The European and UK economy have been quite lacklustre and that creates opportunities for asset allocators such as myself to move my client's capital around to try and capitalise on places where we think there's value and it's getting better, and away from places where we think there's more of a headwind.

Sam Benstead: So, you take quite an active stance to fund management, is that fair to say?

Talib Sheikh: Our job, really, is two-fold. One is to think about asset allocation. How do we move the assets under our guardianship around? And we think about that in two ways: the first is a kind of structural framework, where [we ask where] do we want to be on a kind of six to 12-month type view? And what type of assets do we want to be holding?

The next one is to be a bit more active on what we call a cyclical view. And that typically is a kind of three to nine-month view. And we want to blend those around to make sure that we remain a medium-risk portfolio. Typically, we will be under half the risk of the equity market. So, not a zero-risk portfolio. But certainly that medium risk is where we want to be, blending those assets together to give a decent, repeatable level of yield.

Sam Benstead: You mentioned that interest rates are falling and are expected to fall further. How does this impact asset prices and where are you investing the profit?

Talib Sheikh: It really takes us to government debt. Clearly government debt has gone from being very expensive to arguably being fair value, maybe slightly cheap. So, I think that you need to be quite specific about how much interest-rate risk you're taking in your portfolio. At the moment, we quite favour bonds which have a maturity of somewhere around five years, maybe up to 10 years. We're much more nervous about very long-dated bonds. So, when you're lending money to either the UK government or the US government for 20 or 30 years, we think that's quite risky and unlikely to be compensated. Shorter term, five to 10 years, we are actually finding some interesting opportunities.

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Sam Benstead: And where are those opportunities, and what do you think about the gilt market today?

Talib Sheikh: We're relatively constructive on European government debt. We are seeing inflation fall quite aggressively. The European Central Bank (ECB) were the first central bank to cut.

When I look across to the UK, obviously we just recently had an interest rate cut, and we do think that that is likely to continue. I guess the UK has slowing inflation, but it always has a kind of persistent stickiness of inflation compared to Europe. So, we think that the capacity for the Bank of England to out-cut the ECB is quite limited. And so we tend to be overweight in Europe rather than the UK. But we do still think there are opportunities in the UK.

Sam Benstead: And what about the politics in the UK at the moment and this growing government debt? Is that a risk to UK bond markets?

Talib Sheikh: I think so. I mean we all know about the Liz Truss volatility from the Budget. Obviously, we can't predict that we will return to that type of thing. I think at the moment we're seeing government debt assets across the globe really move higher. And certainly, as we look into 2025 and 2026, governments really are going to have to get a hold of that either by some kind of austerity, cutting the amount of spending, or increasing taxes. And certainly, that's something which we are analysing and thinking through. But certainly, when we look at the UK so far, it looks credible. You've certainly seen the UK's credibility in global markets be enhanced and the gilt markets behaved pretty well.

Sam Benstead: There's a lot going on in the economy today. We've had inflation spiking and interest rates coming up and now falling. Just how difficult is it to be a multi-asset investor today?

Talib Sheikh: As I said earlier, we do think we're in a higher inflation regime. I think you have to break inflation into two parts. One part of inflation is what we call goods inflation. So, things which are imported, things that are manufactured. And clearly we saw a huge spike in that post the Covid opening. So, really, those supply chains were disrupted. You couldn't buy second-hand cars. You couldn't buy new cars. Huge spike in that inflation. And to some degree that has normalised and to some degree that's been the thing that's driven headline inflation lower.

The flip side of that is what we call service inflation. So, how much people pay for goods and services, which are much harder to trade across economies, much harder to trade across borders. And that has been falling, but remains persistently quite sticky. So, when you look at the Bank of England, or you look at the US Federal Reserve, it's services inflation that they're worried about, and that's much harder. That's much less interest rate-sensitive, and so people talk about the last mile being the hardest. That's the area that we're focusing on. But we do think inflation is on the way down. We think this creates opportunities for central banks, not only in the UK, but also in the US, to lower interest rates from here.

Sam Benstead: And we've had this political change in the UK. The Labour government is now in charge. What does that mean for UK investors and UK assets?

Talib Sheikh: We've certainly seen UK assets really be out of favour from global investors for a prolonged period of time. And again, I think you have to split the UK into two parts. One part is the FTSE, which tends to be relatively international, and tends to earn a relatively large proportion of its earnings in US dollars. Compare that to small-caps within the UK or mid-caps, they are much more domestic stocks and, certainly, there is value there. We have some exposure, but I think that's an area where we could see opportunities. And that also is an area that, as global investors feel that the UK's growing, feel that the Bank of England is cutting interest rates and feel that they can get comfortable with the new government's economic policy, that may be an area which offers some opportunity.

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Sam Benstead: Capital growth is also important for investors, even within income portfolios. So, where are the best opportunities to complement the income if you're seeking growth?

Talib Sheikh: I think running a multi-asset income fund, we have three objectives. The first one is to provide a repeatable level of income. The second one is to try and provide some capital growth. That's really why we hold equities. That's why we hold growing alternatives. And the third objective is to make sure that we remain well balanced in that medium-risk part of the portfolio. And why do I think that that growth is important? It goes back to that inflation idea. If we can have assets which can grow through time as well as give income, then we can provide a repeatable level of income to our client. And if we can give them some capital growth on top of that over the medium to long term, then I think we will have achieved our objectives.

Sam Benstead: You invest globally, you look at all asset classes. Is there an area that you think is an under-the-radar opportunity that people at home or other investors haven't noticed at the moment?

Talib Sheikh: I think some of the specialised areas in credit are really interesting. So again, when I look at the portfolios, one of our largest positions is in corporate hybrid. What are these? These are bonds which sit somewhere between a pure bond and an equity. They're typically associated with European banks. People may have heard of them. Typically they're called Cocos. And that's something which you have to do incredibly diligent bond-by-bond analysis, which obviously our analyst team does.

But they offer something which we think is quite attractive, and certainly they're a core part of our portfolio. I do think that the traditional equity-income orientated stocks, which are out there, are being under-appreciated by global investors. I do think that there's been this run into technology, which to some degree has got stretch, but I think it's meant that many of those more traditional, more boring, stocks have been left behind and create opportunities for investors who are prepared to look a little bit below the surface.

Sam Benstead: Running income funds, your biggest competition is probably a money market fund or short-term gilt, or even just a bank account. So, why should investors use your portfolio for income rather than something a bit more secure?

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Talib Sheikh: I think it goes back to that idea about having three objectives. We absolutely want to have an income objective, and income that we're delivering to our clients is higher than cash deposits. It's higher than government debt and it's higher than that available in short-dated credit. We want to also try and provide some capital return. Again, it tries to protect our clients' investment from the ravages of inflation. And it's important, as many retirees live longer and their capital pool has to sustain them for 20 or 30 years.

So, if we can blend in equities at the right time to try and give some capital growth, then we do something which is very different from cash on deposit. But finally, we know that many of our investors are relatively risk-averse. We know that we're running a fund which must have a higher risk than cash deposits, but we want to make sure that we remain in medium risk. And if we can try and balance these three objectives, then I think we do something which is very different from home deposit or very different from holding it in a short-dated gilt.

Sam Benstead: And finally, the question we ask all our guests, do you personally invest in your funds?

Talib Sheikh: I do invest in my funds and we get paid in units of our portfolio. So, our interests are definitely aligned with our investors.

Sam Benstead: Talib, thanks very much for coming in.

Talib Sheikh: Great. Thank you.

Sam Benstead: And that's all we've got time for today. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.