The hunt for a sustainable income
David Prosser explains why investment trusts offer a good choice for investors as interest rates continue to fall.
Headlines can be misleading. Reports in recent days that mortgage rates have begun creeping up are accurate, but they don’t tell the full story. While it’s true some lenders are raising the cost of home loans, reflecting volatility in money markets, the broader trend on interest rates remains downwards. That continues to be a problem for anyone trying to generate income from their savings and investments.
Indeed, the next base rate reduction from the Bank of England’s Monetary Policy Committee (MPC) could come within weeks. The MPC cut rates for the first time in four years in August; many economists now expect a further easing at its next meeting, which takes place in early November.
“Research released by the Association of Investment Companies this week highlighted no fewer than 26 investment trusts currently offering a yield of at least 4.5% a year. The majority of the funds on its list yield more than 5% - and some offer significantly more.”
David Prosser
Where, then, to find resilient income as interest rates come down? Well, as ever, the investment trust sector is a good place to look. Research released by the Association of Investment Companies this week highlighted no fewer than 26 investment trusts currently offering a yield of at least 4.5% a year. The majority of the funds on its list yield more than 5% - and some offer significantly more.
The caveat here is that the share price of an investment trust can fall as well as rise. To take advantage of those yields, you must be prepared for the possibility of your investment falling in value – unlike with a cash savings account at the bank or building society, say. The flipside of that, of course, is that there is always the possibility of capital growth in addition to income.
Just take some care when considering investment trusts for income. A yield is an expression of the income that the fund offers compared to the value of its shares, expressed as a percentage – so a high yield might reflect a depressed share price rather than a generous dividend. You need to consider the prospects for the fund as well as the yield it currently offers. A struggling fund carries greater risk of capital losses – and may, in time, be forced to reduce the dividends it pays to investors.
The good news is there are precautions you can take to reduce the risk of being caught out. Do your research so that you understand how the investment trust has been performing in recent times – and how it might trade in the future. Consider investing in several funds to avoid putting all your eggs in one basket. Check the AIC website for details of each fund’s “dividend cover” – this shows the amount of reserves the fund has in place to maintain its dividend and how long these will last.
You also have the option of investing in one of the AIC’s “dividend heroes”. These are funds that have raised their dividends every year for at least 20 years (and often much longer) – and there are four of them on the AIC’s list of high yielders. There is no guarantee these funds will continue to increase dividends in years to come, but their track record bodes well.
It helps that investment trusts have more flexibility than other collective funds on income. They are allowed, for example, to keep back income earned on their portfolio in good years in order to fund dividends in leaner times. They can also pay dividends out of capital, as long as shareholders have given their permission.
None of which is to say that investment trusts will solve all your income problems. But as the UK moves towards looser monetary policy once again, income seekers will need to cast the net wider to meet their needs. Investment trusts are an excellent place to start.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
