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Helping advisers and planners easily meet their annual cpd requirements
Understand the risks of relying heavily on a single source of portfolio income Know how to think about balancing contractual income streams, such as bonds, against equity-based income sources Explain the role of alternative income assets, such as infrastructure, property and emerging market debt, within diversified portfolios
BEYOND YIELD: BUILDING RESILIENT INCOME FROM DIFFERENT SOURCES
Recognise misconceptions about higher-yielding investments Understand the difference between investing for high current income and investing for income growth Explain the trade-off between yield, income growth and capital preservation to clients approaching or in retirement
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INCOME INVESTING: WHY THE HIGHEST YIELD IS NOT ALWAYS THE BEST OUTCOME
Founded in 1908 and headquartered in Edinburgh, Baillie Gifford is unique in the UK in being a large-scale investment business that has remained an independent private partnership. This ownership structure has allowed efforts to be focused entirely on clients’, and their investments. Baillie Gifford is one of the UK’s largest active investment management firms.
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Describe how emerging market companies have evolved from low-cost manufacturers into globally competitive businesses Explain why index-level performance may not fully reflect underlying company growth and innovation within emerging markets Discuss the potential long-term investment implications of a renewed period of emerging market outperformance
home to world-class companies
02:37 | EMERGING MARKETS
VIDEO
Describe how global supply chains and trade relationships are evolving through trends such as regionalisation, reshoring and geopolitical fragmentation Explain how domestic and regional demand are becoming increasingly important drivers of emerging market growth Discuss the potential investment implications of re-globalisation and supply-chain diversification for emerging market equities
Re-globalisation
02:11 | EMERGING MARKETS
INSIGHTS
By watching this video, you will learn how to:
Describe how emerging market economies have become more resilient compared with previous market cycles Explain how reduced reliance on dollar funding may affect emerging market vulnerability to currency volatility Discuss the potential investment implications of improving emerging market macroeconomic conditions and sovereign credit trends
Emerging resilience
01:47 | EMERGING MARKETS
Describe the role emerging markets play in supporting global economic growth and industrial development Explain how emerging markets are contributing to structural themes such as artificial intelligence and the energy transition Discuss the potential investment implications of increasing global reliance on emerging market infrastructure, resources and technology ecosystems
Developed markets lean on emerging markets
01:44 | EMERGING MARKETS
By reading these articles, you will earn CPD credits and learn how to:
CPD LEARNING
Describe how China has evolved into a significant global innovation and technology centre Identify the structural factors supporting China’s innovation growth Explain the investment opportunities and risks associated with Chinese equities
When ‘made in China’ becomes a compliment, and why investors should care
CPD 30 MINS | EMERGING MARKETS
Describe how EM economies have evolved from manufacturing-led growth models towards innovation-driven sectors Identify the structural growth drivers supporting EM equities Explain the potential investment opportunities and risks associated with EM equities
“Nobody puts EM in a corner”: How emerging markets went from catching up to leading innovation
Understand why inflation remains a key risk facing retirees Articulate the impact sequencing risk has on retirement outcomes Explain the trade-offs between preserving capital, maintaining spending power and leaving a legacy
INFLATION, LONGEVITY AND THE NEW RETIREMENT INCOME CHALLENGE
By the end of this CPD activity, readers will be able to:
• • • •
The discrepancy and the opportunity
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Many investors still largely associate emerging markets with volatile currencies, commodity exporters and the occasional political crisis but not with globally competitive innovation. That view no longer reflects the full picture. Some of the world’s most disruptive companies are now emerging from exactly these markets. In some sectors, emerging market businesses are no longer adapting western models. Instead, they are building new capabilities that are competing with — and in some cases outpacing — their developed market counterparts. Take Chinese electric and autonomous vehicle manufacturers like BYD and Pony.ai. These companies are successfully competing with western rivals on everything from battery technology and autonomous driving systems to pricing and manufacturing scale. In 2025, BYD overtook Tesla as the world’s biggest seller of electric vehicles, marking the first time it outpaced its American rival in annual sales.
And yet, despite all this, emerging market equities remain relatively underrepresented in global indices relative to their share of global economic growth, creating an opportunity for active investors. Emerging economies now account for around 60% of global GDP growth, according to the International Monetary Fund, yet emerging market equities still represent only around 10–11% of the MSCI All Country World Index. This dynamic is becoming increasingly visible at an industry level too. China now accounts for more than 70% of global EV battery production capacity, according to the International Energy Agency, while Taiwan produces the vast majority of the world’s most advanced semiconductors. Critical parts of the global technology supply chain are increasingly concentrated in emerging Asia — an important consideration for investors seeking exposure to industries expected to play a central role in the global economy in the decades ahead.
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The investment case for emerging market equities, however, does not come without risks. Political instability, regulatory intervention, governance concerns and currency volatility can all contribute to periods of market stress. Emerging market equities have also historically experienced sharper drawdowns than developed markets during periods of geopolitical uncertainty, rising interest rates or slowing global growth. Liquidity can also be more limited in certain markets, while corporate governance standards and shareholder protections may vary significantly between regions and companies. Historically, some of the strongest periods of emerging market outperformance have followed episodes of significant volatility and negative investor sentiment, reinforcing the importance of long-term investment horizons. For advisers, this can create both opportunities and challenges in client conversations. While emerging market equities can experience sharper periods of volatility during global shocks and sentiment-driven selloffs, they may also offer long-term growth potential and diversification benefits for investors willing to tolerate short-term volatility. All of this means that position sizing, time horizon and client risk tolerance remain important considerations for advisers. However, excluding emerging market companies from long-term portfolios would be shortsighted. Investors focused primarily on developed markets risk overlooking some of the most significant sources of future global growth and innovation.
Positioning EM in client conversations
Describe how emerging market economies have evolved from commodity- and manufacturing-led growth models towards innovation-driven sector Identify the structural growth drivers supporting emerging market equities, including demographic trends, digital adoption and financial inclusion Explain the potential investment opportunities and risks associated with emerging market equities, including volatility, governance considerations, regulatory intervention and currency risk. Assess how emerging market equity exposure may contribute to long-term portfolio diversification and client investment objectives
So, what are investors missing when it comes to emerging market companies? In many cases, they are overlooking businesses benefiting from structural growth trends and the advantages of operating without outdated legacy infrastructure. Rising middle-class populations, supportive demographics and accelerating technology adoption across parts of Asia and Latin America are creating conditions for faster innovation-driven growth than in many developed economies facing ageing populations and more mature consumer markets, a trend highlighted in research from institutions including S&P Global and the International Monetary Fund.
For long-term investors, emerging market companies provide access to structural growth themes that may unfold over decades rather than quarters, including rising middle-class consumption, digital financial inclusion, healthcare access, automation and energy transition infrastructure. These dynamics also help explain why many investors favour an active approach within emerging markets. While benchmark indices have evolved significantly, they can still contain large concentrations in state-owned enterprises, financial institutions and cyclical businesses. According to Baillie Gifford’s emerging markets investment team, identifying long-term winners in the asset class often requires investors to look beyond short-term macroeconomic noise. Instead, the focus should be on factors such as earnings growth, competitive advantages, governance standards and structural industry trends.
The absence of legacy infrastructure and the need to innovate through constraints have become competitive advantages, allowing businesses to scale innovation at remarkable speed.
In other words, emerging markets are no longer “catching up” with their western counterparts. Increasingly, they are leading the way, influencing global consumer behaviour and technological innovation.
The changing composition of emerging market equities is also telling. Historically, many investors associated the asset class primarily with state-owned banks and commodity producers. Today, information technology accounts for more than 30% of the MSCI Emerging Markets Index, while communication services account for close to 9%, according to MSCI sector data. This reflects the growing influence of technology platforms, semiconductors and digital consumer businesses across emerging economies.
Other sectors in Asia, including digital payments, have in some cases evolved faster than their developed market equivalents, helped by the fact they were built without the burden of legacy infrastructure in the first place. Companies such as Grab and Sea Limited, for example, helped pioneer mobile-first “super app” ecosystems integrating payments, ecommerce and financial services across Southeast Asia. The contrast with developed markets is striking. According to Worldpay’s Global Payments Report 2026, digital wallets represented 77% of ecommerce transaction value in Asia-Pacific in 2025, compared with closer to 40% in the US and UK, where card-based payment systems remain more deeply entrenched. In many Asian markets, the absence of widespread legacy banking infrastructure allowed mobile-first payment ecosystems to scale more rapidly. And in Latin America, digital banking and ecommerce platforms like Nubank and MercadoLibre are busy building digital-first financial ecosystems for millions of previously underbanked consumers, often leapfrogging traditional banking infrastructure in the process.
By the end of this CPD activity, DELEGATES will be able to:
How China built its innovation machine
For many years, “made in China” implied imitation and scale from a western perspective, but this view needs updating. In today’s reality, “made in China” increasingly means technological capability and innovation leadership. China is no longer simply replicating western ideas at a lower cost; in several sectors, Chinese companies are now competing at the frontier of innovation through proprietary research, patent creation and advanced manufacturing. For long-term investors seeking exposure to structural growth trends, moving beyond the traditional perception of China as the world’s factory floor is therefore becoming essential. One indication of this shift is China’s growing influence in global patents and pharmaceutical licensing. A decade ago, China accounted for less than a quarter of global patent filings, according to the World Intellectual Property Organization (WIPO), and played only a limited role in pharmaceutical licensing markets. By 2025, however, China accounted for almost half of global patent filings, according to WIPO data, while Chinese biotech companies were involved in deals representing close to 40% of global pharmaceutical licensing activity, based on Evaluate Pharma estimates. China’s lead over many of its global competitors has widened dramatically in recent years. According to WIPO, the country’s IP office received 1.8 million patent applications in 2024 — more than three times the number submitted to the US Patent and Trademark Office — and, among the world’s five largest IP offices, recorded faster patent filing growth than the US, Japan and South Korea since 2000.
This transformation did not happen overnight or by accident: over the past two decades, China has relied on heavy investment in research and development, a deep STEM talent pool and the advantages of a vast domestic market to accelerate its innovation progress. Rising geopolitical tensions and restrictions on access to western technology have accelerated rather than slowed China’s push towards self-sufficiency, particularly in strategically important sectors such as semiconductors and AI. Government policy has supported this direction. Beijing’s “Made in China 2025” strategy prioritised industries including semiconductors, robotics and electric vehicles, while its “dual circulation” framework strengthened the focus on domestic innovation and reducing reliance on overseas supply chains.
China’s innovation advancement is especially evident across autonomous driving, electric vehicles, biotechnology and semiconductors industry. In autonomous driving, Baillie Gifford’s emerging markets team points to Pony.ai, which is already deploying robotaxi services across major Chinese cities. Separately, Goldman Sachs Research estimates that around 500,000 robotaxis could be operating across more than 10 Chinese cities by 2030. The EV supply chain tells a similar story. According to SNE Research, CATL and BYD together accounted for more than half of global EV battery installations in 2025, highlighting China’s growing lead in one of the world’s most strategically important industries. Biotechnology has become another major area of competitive strength for China. McKinsey estimates that China now contributes around 30% of the global innovative drug pipeline, up from just 3% in 2013. Companies such as BeiGene are benefiting from faster clinical trial recruitment, lower development costs and access to large patient populations.
From robotaxis to biotech
Describe how China has evolved from a low-cost manufacturing economy into a significant global innovation and technology centre. Identify the structural factors supporting China’s innovation growth, including research investment, industrial policy and domestic market scale. Explain the investment opportunities and risks associated with Chinese equities, including geopolitical, regulatory and governance considerations. Assess how exposure to Chinese innovation-led sectors may influence long-term portfolio construction and diversification decisions for different client risk profiles.
All this carries significant implications for global competition as Chinese companies are forcing western rivals to respond to faster product cycles, lower costs and rapid advances in technology.
China’s long-term priorities are unambiguous, with ambitions to become a global science and technology leader by 2035 and a strategic focus on areas such as semiconductors, artificial intelligence, biotechnology, quantum computing and advanced manufacturing.
Not all parts of China’s market are benefiting equally from these trends, creating a wide gap between companies driving innovation and those still tied to older economic models. Broad exposure alone may therefore miss many of the businesses driving China’s innovation story. As geopolitical tensions, regulatory intervention and governance concerns remain relevant across the market, selectivity and careful risk assessment cannot be overlooked. Some businesses may benefit from long-term trends linked to AI, healthcare innovation or the energy transition, while others remain weighed down by debt pressures, weaker domestic demand or political uncertainty. This means a more active approach is needed to identify companies with durable competitive advantages, strong management teams and the ability to navigate a fast-changing environment. China’s innovation story still divides opinion among investors, and periods of volatility are unlikely to disappear. But according to Baillie Gifford’s investment teams, focusing solely on near-term macroeconomic concerns risks missing a much bigger structural shift already underway: China’s transition from low-cost manufacturing hub to one of the world’s most important centres of technological innovation.
Not all China exposure is equal
At the same time, global supply chains remain deeply interconnected despite rising geopolitical tensions. Western governments may be growing more cautious around Chinese technology and AI-related risks, yet many strategically important industries, such as electric vehicle batteries, pharmaceuticals and semiconductors, remain heavily exposed to Chinese manufacturing capacity, scientific research and critical components. For investors, this changes the conversation around China exposure, because the opportunity is no longer limited to domestic economic growth or consumer demand. It is also about understanding the growing influence Chinese companies exert across global industries, and assessing how those businesses fit within long-term portfolios alongside the geopolitical, regulatory and governance risks that still come with investing in China.
For advisers, the challenge is therefore becoming more nuanced than simply deciding whether to “allocate to China” or not.
The more important question may be which parts of China’s economy are likely to shape global industries over the coming decade and whether portfolios are positioned to capture that change in a measured and suitable way. That requires balancing long-term growth potential against very real geopolitical, regulatory and governance risks, while recognising that some of the companies driving structural change in AI, healthcare, automation and clean energy are now emerging from China itself.
• • • • •
When a high yield is a warning sign
A 6% yield looks more attractive than a 3% yield. After all, most people are used to thinking about income through savings accounts, where a higher interest rate generally means more money in their pocket, so applying the same logic to investments can feel quite natural. Investment yield, however, works differently, and a high number does not necessarily mean that an investment will provide more income over the long term. Because yield is calculated against the price of an investment, it can rise when the price falls. In some cases, a high yield reflects a loss of capital rather than an improvement in the income being paid. An investment paying a high income today may also struggle to maintain it, particularly if little is being retained for future growth; one starting from a lower yield may have more scope to grow its income and preserve capital over time. According to the Office for National Statistics, a woman aged 65 in the UK in 2024 could expect to live for another 22.7 years on average, and a man for another 20 years, based on cohort life expectancy projections.1 When a portfolio is expected to support a client through retirement, it can be helpful to think about income differently. The highest yield today may not provide the best outcome over decades, which raises two questions for advisers: how sustainable is the income, and what is happening to the capital behind it?
Yield does not forecast return: it is a ratio of income to price, so a higher number does not necessarily mean a better investment. In bond markets, a high yield is often compensation for risk – whether that comes from the possibility of default, inflation or currency movements. In effect, the market is putting a price on what it is worried about. The same yield can mean very different things across different investments. A 6% gilt yield and a 6% equity yield represent different claims, with different seniority and volatility. Even within the same asset class, a yield materially above its peer group should have a structural explanation; without one, the gap itself can be a warning sign.
Income investing: Why the highest yield is not always the best outcome
CPD 30 MINS | income
A coupon, dividend, option premium and return of capital provide income in different ways, and not all are equally repeatable. In equities, payout ratios and free cash flow can indicate whether payments are covered; in credit and sovereigns, advisers can look at debt-servicing capacity, refinancing schedules and interest costs relative to revenue. A recession, dividend-cutting cycle or period of corporate defaults can put those income streams under pressure, so the distribution itself needs to be stress-tested, not just the underlying capital. Currency adds another consideration: a high unhedged yield may simply reflect FX risk, while hedging costs come directly off the return. Bond maturities or falling rates can reduce the income available when money is reinvested, while reliance on a handful of issuers leaves a portfolio more exposed to individual cuts. Fees charged to income will reduce the amount ultimately paid to the client.
Can the income be sustained?
Recognise misconceptions about higher-yielding investments Assess the sustainability of an income stream beyond the headline yield Recognise the key warning signs that a high yield may be a yield trap Understand the difference between investing for high current income and investing for income growth Explain the trade-off between yield, income growth and capital preservation to clients approaching or in retirement
If the yield has risen because the price has fallen rather than because the income has grown, the apparently attractive yield may be signalling trouble. Advisers can also examine how the income is funded: borrowing, asset disposals or a return of capital are less sustainable sources than earnings or revenue.
Sustaining the income also depends on preserving the capital behind it. A 6% yield combined with a 3% annual capital loss produces a 3% total return; the following year, that 6% is paid on a smaller pot. A high payout ratio can make the loss harder to recover, as less capital is retained for reinvestment. The effect can be greater in decumulation, where selling investments after a market fall can crystallise losses and leave fewer units to participate in a recovery. . The latest Financial Conduct Authority retirement income data show that sales of drawdown policies rose 25.5% year on year, from 278,977 in 2023/24 to 349,992 in 2024/25.2
When income comes at the expense of capital
Inflation can erode a fixed coupon in much the same way in real terms, reducing its purchasing power even when the cash payment remains unchanged.
High current income provides more cash today; income growth starts from a lower base but aims to increase that cash flow over time while preserving capital. Higher static yields are often associated with mature or stressed issuers, while income growth is more likely to come from businesses that retain capital to reinvest. A portfolio yielding 3% with income growing at 6% a year, for example, would see its annual payment overtake that of a static 6% yield after roughly 12 years. Someone drawing from a portfolio for 30 years has different requirements from someone with a five-year horizon, particularly when withdrawals can compound the effects of capital losses. Total return – income plus changes in capital value – therefore needs to sit alongside yield when assessing what a portfolio can support. If a fund yields 6% but delivers a 4% total return, part of that distribution is effectively coming from the client’s own capital. Thinking in pounds and pence rather than percentages can make the trade-off clearer. Sustainable withdrawals should be based on expected total return rather than anchored to the headline yield. A strong income record should not disguise persistent capital erosion, just as capital growth should not disguise an unreliable income stream; in retirement, both have a job to do.
Deteriorating cover is another warning sign. In sovereign debt, this can include interest costs rising relative to revenue, shortening issuance maturities and growing reliance on domestic banks to absorb supply. Market pricing may indicate that a payment is at risk before it is actually missed. Credit markets often show signs of trouble before equity markets, so a widening credit spread alongside a high dividend yield can be a warning sign.
Income today or income over time?
The highest yield, then, will not always produce the best outcome. What counts is the income a portfolio can sustain over time, in pounds and pence, without eroding the capital needed to support it.
Sources
1. ons.gov.uk 2. fca.org.uk
Different assets, different risks
During the low-interest-rate years that followed the global financial crisis, cash and high-quality bonds provided relatively little income, so investors looking for a yield had to take more risk through equities and real assets. Now that cash and bonds can contribute meaningfully again, the range of income-producing investments is broader. But more choice brings different risks. Higher yields can make bonds more useful income sources again, although the headline yield still needs to be weighed against risks such as tight credit spreads, inflation and interest-rate sensitivity. A resilient income portfolio needs different cashflows and return drivers, while balancing the predictability of income today with the potential for income and capital to grow over time.
The truth is that every source of income can disappoint, according to Baillie Gifford’s Monthly Income investment team. Equity dividends can be cut, corporate bonds can default, property rents can fall and government bonds can lose value when inflation rises, while currency movements can reduce the value of overseas income. If one company, sector or asset class makes up a disproportionate share of a portfolio’s income, any disruption can directly affect the client’s spending plan. But concentration can exist even when a portfolio owns plenty of different securities. Fifty dividend-paying companies in similar sectors may still amount to one source of income, while different asset classes can share the same underlying risk. Bonds, property and infrastructure, for example, can all be sensitive to changing interest rates. Diversification therefore depends on where the cashflows come from and what drives their returns. Dividends, coupons, rents and regulated infrastructure revenues may come from different sources, but diversification is weaker if they are vulnerable to the same changes in inflation, growth or interest rates. It cannot prevent losses, but it can reduce the chance that one event damages the whole income stream and give a manager flexibility to invest elsewhere when opportunities arise.
Beyond yield: Building resilient income from different sources
Just as different asset classes respond differently to changing economic conditions, those conditions can also vary considerably between countries. One central bank may be cutting interest rates while another is still raising them, so investing globally can give an income portfolio access to different economic and interest-rate cycles rather than tying it largely to what is happening in the UK. Investing globally also widens the opportunity set beyond the sectors and companies that dominate the UK market. It opens up a much wider range of companies, credit markets, property sectors, infrastructure assets and government borrowers. Emerging markets can add to that, with some countries offering high real interest rates, stronger balance sheets or different inflation trends. That makes country selection important, rather than simply choosing the markets with the highest yields Yet global diversification also brings currency risk. A high yield earned overseas can be undermined if the currency falls against sterling. That’s why Baillie Gifford’s Monthly Income Fund hedges most of its foreign-currency exposure back to sterling, while retaining only deliberate currency positions. And spreading investments across many countries will provide limited diversification if they are ultimately all driven by the US dollar or US interest rates.
Looking beyond the UK
Understand the risks of relying heavily on a single source of portfolio income Explain how different income-producing asset classes behave across inflation, growth slowdowns and changing interest-rate expectations Understand where global diversification can improve income portfolio resilience Know how to think about balancing contractual income streams, such as bonds, against equity-based income sources Explain the role of alternative income assets, such as infrastructure, property and emerging market debt, within diversified portfolios
Equity dividends are not guaranteed, but companies that can raise prices and grow their earnings may also be able to increase their dividends over time, helping income keep pace with inflation. However, share prices can be more volatile when expectations for economic growth weaken. Government and investment-grade bonds provide more predictable income because their coupons are normally fixed. They can perform well when growth and inflation are falling, but rising inflation can erode the value of that income and push bond yields higher, causing prices to fall. High-yield corporate bonds offer more income and can be less sensitive to interest-rate movements, but they carry greater economic risk: during a slowdown, credit spreads can widen and defaults can rise, and thus they can behave more like equities in some market regimes. Property and infrastructure add another source of income through rents, regulated revenues and contracted payments, some of which can rise with inflation. Yet higher interest rates can increase financing costs and put pressure on valuations. Emerging-market debt behaves differently again. Local-currency bonds can offer high real yields and exposure to countries at different stages of the interest-rate cycle, although currency movements add risk. Hard-currency emerging-market bonds remove direct exposure to the local currency but remain sensitive to changes in credit spreads and US Treasury yields Cash, meanwhile, becomes more attractive as interest rates rise, but the income it provides can fall quickly when central banks begin cutting rates.
Equity dividends are less predictable and can be cut, but companies that grow their earnings can also increase their dividends over time. This gives equities a different role, as alongside income, they offer the potential for both income and capital to grow.
How income assets respond as conditions change
Property and infrastructure add another source of income through rents, regulated revenues and contracted payments, some of which can rise with inflation. Yet higher interest rates can increase financing costs and put pressure on valuations. Emerging-market debt behaves differently again. Local-currency bonds can offer high real yields and exposure to countries at different stages of the interest-rate cycle, although currency movements add risk. Hard-currency emerging-market bonds remove direct exposure to the local currency but remain sensitive to changes in credit spreads and US Treasury yields Cash, meanwhile, becomes more attractive as interest rates rise, but the income it provides can fall quickly when central banks begin cutting rates.
As well as diversifying where income comes from, investors need to consider the type of income they hold. Bonds, for example, can provide greater certainty than equities. Provided the issuer remains solvent, investors know the coupon they are due to receive and when the principal should be repaid. This can make bonds a useful source of current income, although contractual does not mean risk-free. The issuer could default, while changes in interest rates will affect the bond’s price. And because the coupon is usually fixed, inflation can reduce what that income will buy over time.
Balancing income today with growth tomorrow
Clients in retirement may need their portfolio to support them for 20 or 30 years. A high bond coupon may meet an income need today, but it does not necessarily address what that income will buy decades from now. The balance between bonds and equities should therefore reflect both the client’s time horizon and the opportunities in each market, rather than relying on a fixed historical allocation.
Property, infrastructure and emerging-market debt can broaden the sources of income further. Property provides rental income, which can grow where demand for good assets is strong, while infrastructure can offer regulated or contracted revenues with some protection against inflation. Regulated businesses may also be able to grow their income by investing more capital and earning an agreed return on it. Baillie Gifford’s Monthly Income Fund invests in listed property and infrastructure, which allows the managers to adjust their holdings as prices and opportunities change. As we head into Q4 2026, the team believes infrastructure fundamentals remain strong, although valuations are less obviously cheap after recent performance. Property rents are generally holding up, and listed property in the UK and Europe is cheaper than in the US. The managers are also constructive on emerging-market debt, but they remain selective. Because differences between countries are significant, they focus on whether the income justifies the risk rather than simply buying the highest-yielding markets.
The role of alternative income
What does a resilient income portfolio look like?
A resilient income portfolio does not depend on one dominant source of yield. It combines different sources of income, while balancing the need for income today with the potential for income and capital to grow over time. A high yield is of little use if a company cannot sustain its dividend, a borrower struggles to service its debt or a property cannot support its rent. Holding some cash in reserve can also give managers the flexibility to invest when markets fall, rather than having to sell assets at depressed prices. And while market prices will inevitably move, a fall in value does not necessarily mean that the income itself is under pressure. A listed property or infrastructure holding, for example, may fall in price while its underlying income continues. Repeated dividend cuts or defaults, however, pose a more direct threat to clients relying on that income.
Because some risks may not be obvious until market conditions change, Baillie Gifford’s Monthly Income team formally stress-tests the portfolio every six months across different economic scenarios. This can reveal risks shared across investments that may not be apparent from their asset-class labels.
With a wider range of income sources to choose from, investors now have greater scope to build portfolios that can respond to different economic conditions. But resilience comes from understanding what drives each income stream and how those drivers might change. Combining contractual income with sources that can grow, while diversifying across assets and markets, can help provide income today without losing sight of what clients may need in the years ahead.
In 2022, for example, equities and bonds fell together as rising inflation and interest rates hurt both.
Do you believe inflation remains one of the most significant risks facing retirees?
Retirement is not simply an accumulation portfolio with withdrawals attached. Once somebody starts spending from the pot, the timing of market returns begins to affect the outcome as well as the average return. Retirement can now last for several decades, so a portfolio has to produce cash today without giving up the growth needed to support spending in 20 or 30 years. Inflation adds to that challenge. A fixed income that feels adequate at retirement can lose a surprisingly large amount of purchasing power over time.
Higher interest rates have at least created more income choices. Advisers can now compare cash, annuities, bonds, equities and multi-asset income on more equal terms rather than being pushed towards risk simply because safer assets yield almost nothing. Yet the underlying trade-off remains: clients often want a reliable income for life while retaining access to their capital. No investment structure can maximise both, so advisers need to consider which risks a client is willing to accept, whether that is uncertain income or capital, inflation erosion or reduced flexibility.
Inflation, longevity and the new retirement income challenge
They are not opposites. A good natural-income portfolio still needs capital growth, while a total-return portfolio will still receive dividends and coupons. The distinction is mainly about how the client’s withdrawals are funded. Natural income reduces dependence on selling units, so a market fall does not automatically force a capital sale to pay the month’s bills. A total-return approach potentially gives the manager a wider opportunity set because each investment does not have to produce income, and withdrawals can be matched more closely to the client’s spending.
How should advisers think about natural income versus a total-return approach when building retirement portfolios?
Explain the challenges of generating retirement income today Understand why inflation remains a key risk facing retirees Understand how to think about natural income versus a total-return approach Articulate the impact sequencing risk has on retirement outcomes Explain the trade-offs between preserving capital, maintaining spending power and leaving a legacy
Yes, particularly because retirement is long. Even fairly ordinary inflation compounds into a substantial loss of purchasing power when income stays flat for 20 or 30 years. A flat £1,000 a month at the end of 2021, for example, had the purchasing power of roughly £808 by mid-2026. The payment had not fallen, but what it could buy had. Assets that look safe in nominal terms do not necessarily solve the problem. A conventional gilt can provide a known coupon and repayment of capital at maturity, but the purchasing power of those payments still depends on inflation. . And inflation can damage capital as well as income: in 2022, rapidly rising inflation pushed interest rates higher while equities and bonds fell. Rather than trying to match every monthly inflation figure, a long-term retirement portfolio can hold assets with the potential to grow income and capital over several years. These might include companies with pricing power and dividend growth, real assets where rents or regulated revenues can rise, and bonds where the starting real yield compensates the investor. Baillie Gifford’s Monthly Income objective is deliberately framed over rolling five-year periods. Inflation can be impossible to match during a sudden spike, but the long-term income plan should still aim to preserve purchasing power.
Many retirees focus on the income their portfolio generates naturally. Is this always the most effective way to fund retirement spending? What alternatives are there?
Natural income has a clear advantage: if dividends, coupons and other cashflows cover a meaningful part of spending, the retiree is less dependent on selling investments (to convert capital to income) after a market fall. But natural income should not become a target at any price. If a client needs 6% but the portfolio naturally yields 4%, forcing it to yield 6% may introduce more risk than planning some limited, controlled capital withdrawals. There are several alternatives. An annuity exchanges capital and flexibility for guaranteed lifetime income, which can be valuable for essential expenditure. A cash or bucketing approach can set aside near-term spending so investments do not have to be sold after a market fall, although holding too much cash can drag on long-term real returns. A total-return approach funds spending from dividends, coupons and planned asset sales. It offers greater flexibility and a wider investment universe, but the timing of those sales becomes part of the sequencing risk. A blend can therefore make sense: guaranteed income might cover essential costs, natural income can contribute to regular spending and capital can remain accessible for larger or less predictable needs.
Sequencing risk is not about the average return but the order in which returns arrive while somebody is withdrawing money. If markets fall early in retirement, the client may have to sell more units to produce the same cash withdrawal. Those units are then gone and cannot participate in an eventual recovery. This explains why two retirees with the same starting pot and portfolio can experience very different outcomes simply because they retire in different years. The early years can be particularly sensitive if a large drawdown coincides with substantial withdrawals.
Why can sequencing risk have such a profound impact on retirement outcomes?
Capital has several jobs: it supports future spending, provides the base for future income and, for some clients, leaves something behind. It is impossible to maximise all three at once. Refusing ever to spend capital can be too restrictive. A planned withdrawal for care costs, a new roof or helping a family member may be entirely consistent with the purpose of retirement savings. But spending capital has a permanent consequence: a smaller portfolio means less capital to generate future income and compound.
What trade-offs exist between preserving capital, maintaining spending power and leaving a legacy?
Nor is preserving nominal capital necessarily enough. A £500,000 pot that is still worth £500,000 after 20 years will have lost real spending power if prices have risen.
Markets have also become more volatile, and correlations can change. The assumption that equities provide growth while government bonds always protect against falling equities did not work in 2022, when both fell.
Why has the challenge of generating retirement income become more complex than it was a decade ago?
Its weakness is sequencing. If a large part of a withdrawal has to be funded by selling assets, a prolonged fall early in retirement can permanently reduce the number of units left to participate in a recovery.
Capital growth therefore matters under either approach. Today’s capital is the base from which tomorrow’s income is generated. Advisers can start with the client’s spending needs, other guaranteed income, time horizon and need for flexibility, rather than allowing portfolio yield to dictate the spending plan.
Natural income can reduce the problem by providing cash without requiring a unit sale, although it cannot remove sequencing risk. Other tools include guaranteed income, a sensible liquidity reserve, diversification, flexible spending and changing the asset mix as valuations change. There is a behavioural element too. Retirees who see their pot falling while drawing from it may reduce risk at precisely the wrong time. Within Monthly Income, this is one reason the managers focus closely on the reliability of natural income and operate an income-risk guideline that seeks to prevent forecast annual income from falling by more than 10%.
An annuity illustrates the trade-off clearly: the client gives up access to capital in exchange for lifetime income and mortality pooling, potentially leaving less as a legacy. Staying invested offers more flexibility and the possibility of retaining a real capital base, but neither income nor capital value is guaranteed. The right balance will depend on other guaranteed income, essential and discretionary spending, health, time horizon and legacy wishes. From a Monthly Income perspective, regular spending should be supported, as far as practical, by the cash the assets naturally produce, while preserving the capital base for future income and flexibility. But that does not mean capital should never be spent. This interview was conducted with Steven Hay, Investment manager at Baillie Gifford.
