Rob Burdett, co-head of Thames River Multi-Capital, highlights some of the challenges facing today's income seekers and suggests that going back to investment basics can help provide the solution.
Cash produces measly returns
With UK base rates having stood at 0.5% since early 2009 and unlikely to rise significantly anytime soon, savings accounts (and cash ISAs) currently offer little in the way of interest. And their measly returns are further compounded when viewed against the backdrop of stubbornly high inflation that continues to erode the spending power of the pound. For investors requiring an income therefore, cash savings are becoming less and less of a realistic option.
The ups and downs of equity income
Even if you are looking to grow the value of your investment rather than take an income from it, investing in equities with income in mind can make real sense. For a start income has historically proven to be a very important element of the total return from equities, with the reinvestment of dividends significantly boosting capital growth. The 2011 Barclays Capital Equity Gilt Study shows that while the real (post inflation) value of £100 invested in UK equities in 1899 without dividends reinvested would have been £180 at the end of 2010, the reinvestment of gross dividends would have boosted this to an astonishing £24,133. Of course investing in shares for income isn't without its potential pitfalls and the dividend yield of the FTSE 100 Index has fluctuated significantly over the last five years thanks to cuts from the banking sector and BP - one of the UK's biggest dividend payers - suspending its distributions in the wake of the Deepwater oil crisis.
Recent indications suggest a relatively positive outlook for income from equities with Capita Registrars' latest UK Dividend Monitor showing that British companies paid out £15 billion in dividends during the first three months of 2011 - an increase of over 10% compared with last year. There are a few important things for UK equity income investors to bear in mind however - not least among them the heavily concentrated nature of UK dividend payments. Five companies account for around 40% of the UK's dividend yield, meaning that should any one of these big companies cut back or suspend their dividends there could be a material impact on the overall market yield. Factors like this, together with the ongoing development of the dividend culture around the world, mean that equity income investors are beginning to cast their net wider with European, global and even emerging market equity income funds now readily available.
The steady and reliable income producing characteristics of bonds have made them a popular choice with investors. And choice is certainly something investors have no shortage of when it comes to bond funds. Today there are funds across the risk/reward spectrum, from the perceived safety of government and investment grade bonds through to the higher returns potential of high yield bonds as well as increasingly popular strategic bonds that are able to invest in bonds of all types. As with all investments, however, investors need to be mindful of the risks involved. During the credit crunch, through the resulting downturn and up until the present day the pitfalls (and benefits) of bond investment have been keenly highlighted. Many corporate bonds fell sharply in value in late 2008 and into 2009 before posting an impressive recovery. Government bonds meanwhile performed well during the downturn when investors flocked to assets perceived as safe, but currently have a shadow cast over them by massive levels of government borrowing.
The income solution
Despite the challenges outlined above there are still plenty of reasons for income seekers to be cheerful. Not least among them is the greater level of choice investors targeting an income now enjoy. As well as the traditional routes of cash, equities and bonds it is easier than ever to tap into other assets with real income potential, including the likes of commercial property and absolute return funds. Whatever the chosen route to income however, investors need to be mindful of the potential pitfalls as well as the attractions.
At Thames River Multi-Capital we are all too aware of the challenges and are firm proponents of the benefits of one of investment's basic principles - diversification. In our view the best way to achieve an attractive and crucially, reliable income is to derive it from as many sources as possible thus tapping into a range of attractive income drivers whilst at the same time tempering the potential impact of fluctuations in any one particular area. Our Distribution Fund is underpinned by this thinking as by investing across a range of asset classes and between 20-30 funds it contains around 700 individual income producing assets. This diversification has been key in helping it achieve one of the highest and most reliable income streams (currently 5.5%*) in the IMA Cautious Managed sector.
For more information on the Thames River Distribution Fund visit http://mmdistribution.thamesriver.co.uk/
*Source: Thames River as at 30 April 2011.
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