On the search for inflation busting returns?

The investment companies team at analyst Stifel certainly got its timing right. A week or so ago it published an interesting bit of research highlighting the 23 investment companies currently offering a dividend yield of more than 4%. Within days, the Office of National Statistics’ monthly bulletin revealed that inflation in the UK has now risen to 4.2%, well ahead of expectations.

Income-generating investment companies are a good option if you’re worried about higher prices. For one thing, their track record of delivering inflation-beating yields looks pretty impressive. Also, the unique ability of investment companies to build up revenue reserves that can be used to subsidise dividends in lean times offers the promise of consistency as well as performance.

At the very least, if you buy an investment company on an inflation-beating yield, you have a good prospect of not losing money in real terms. That’s quite a contrast to cash savings accounts, for example, where millions of savers earning pitiful savings rates are now suffering quite sizeable (and guaranteed) losses once you take inflation into consideration.

From that select group of 23 investment companies picked out by Stifel, 18 offer a yield of 4.2% or more, matching or beating the latest rate of inflation. And half of that group actually sit on yields of 5% or more, which is where some economists expect inflation to get to in the first half of 2022.

That very top selection still includes plenty of choice. There are UK funds, including Aberdeen Standard Equity Income and BMO UK High Income, as well as funds with a more international flavour such as European Assets. There are also some more specialist plays, with Henderson Far East Income, on a yield of 7.9%, topping the list, followed by BlackRock Latin American on 6.3%.

In other words, income-seeking investors with quite different attitudes to risk and portfolio construction should be able to find something of interest amongst the high-yielding funds. Stifel’s analysis also provides reassurance on sustainability of pay-outs: it points to the “established revenue reserves” of many of the investment companies on its list.

What about capital performance? After all, while a healthy chunk of income is important in the face of rising inflation, investors do not want it at the expense of their starting capital.

Well, performance naturally varies from fund to fund, but the overall statistics are encouraging. The average UK equity income fund delivered a share price return of 43% over the five years to the end of October – and 153% over 10 years. That equates to average annual returns of around 7.4% and 9.7% respectively. Global Equity Income funds have done even better, delivering 57% and 180% over the past five and 10 years.

In truth, investors could have earned more from other sectors. Nevertheless, these are solid capital performances from funds typically bought with yield in mind; a good quality income stream does not have to mean giving up on capital gains. Indeed, focus on total return and the case for equity income investment companies begins to look compelling – you can always reinvest your dividends if you don’t need to draw down the income.

That’s important. The Bank of England expects inflation to peak during the first half of next year and then to decline back towards the 2% target rate. Others are not so confident, in which case yield is going to remain vital, but even if the Bank is spot on, the total return case for equity income funds will remain strong.