How do income funds work?

Income can be a critical component of total return. In the US there have been periods, such as the 1910s, 1930s, and 2000s, where all investor returns came from income alone.  

While the data above is for the S&P500, the ASX is no different. Between 2007 to 2020, all returns for investors in the ASX were from income, despite significant market events like resource and housing booms.

While dividends can provide a reliable income stream, they are not guaranteed. During economic downturns, companies may cut dividends to conserve cash, as seen during the COVID-19 pandemic. Over-reliance on dividends can also lead to a lack of diversification, particularly if investors focus on high-dividend sectors like banks and resources in Australia.

Interest rates can be highly volatile. For example, in August 2008, the RBA cash rate was 7.25%, but by the following year, it had dropped to 3.00%. This volatility makes it difficult to rely on interest income for a stable return.

At Talaria, our unique implementation process that uses put options to enter stock positions, generates consistent and differentiated premium for our investors. The premium, whether taken as income or used to reduce our stock entry price offers several benefits:

• Consistency: Provides a steady income stream that is not dependent on market conditions or company decisions.
• Risk Management: Creates a buffer against losses and reduces portfolio volatility.
• Diversification: Offers a source of return that is not correlated with traditional income sources.

The other feature of such a strategy, unlike dividends and interest, is that it is priced off volatility. The higher the uncertainty about the future, the higher the premiums we collect to compensate for that uncertainty.

In the current economic environment, characterised by high starting valuations, inflation, and the impacts of monetary policy, having a consistent and diversified source of income is invaluable.