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Where to find comfort amid the income drought

10 July 2020

David Prosser looks at the income advantages of investment companies and suggests which could be best placed to help.

Where will you turn for income on your savings and investments? Even before the Covid-19 pandemic, interest rates were stuck close to an all-time low, but the Bank of England’s decision to cut base rates to just 0.1% in response to the crisis was unprecedented. It means the interest paid on your bank and building society savings accounts is now negligible.

Until Covid-19 struck, moreover, the stock market offered a better deal for income seekers, with many companies paying record dividends in recent times. But now those companies are struggling, they are cancelling or drastically reducing their pay-outs. New research from the stockbroker AJ Bell predicts dividends from large UK companies will be 17% down in 2020 – it also expects dividends to remain depressed for the next two years.

Shelter from the storm

However, there is one place to look for some respite. Investment companies have some unique advantages that often enable them to maintain the income they pay to savers and investors even during very tough times.

Unlike other types of investment fund, they are allowed to build up “dividend reserve” funds, by keeping back some of the income they earn on their investments in good years. This money can then be used to support income payments in investors during leaner periods. In addition, investment companies also have the option of paying income from capital, where their investors have given their permission. This also helps funds to continue paying out during challenging periods.

It’s important to recognise that dividend reserve funds are not bottomless pits. In time, even investment companies with generous safety nets could run out of cash to sustain income if the crisis persists – if there is a disastrous second wave of Covid-19, for example.

However, investment companies have, in the past, proved remarkably resilient. The Association of Investment Companies maintains a list of “dividend heroes” – funds that have raised their dividend payments every year for an extended period; some of these funds have been able to do that for as long as 50 years, spanning other periods of turmoil such as the oil crisis of the 1970s and the global financial crisis in 2008 and 2009.

Which funds to choose

To pick specific investment companies to generate income, you may need to take advice from an independent financial adviser. The right fund for you will depend on your individual circumstances and your investment goals.

However, several analysts publish lists of funds they think have the capacity to do well – and to continue delivering a good level of income. Citywire, for example, has just published a selection of 10 UK equity income investment companies that it thinks are particularly well-placed to weather the storm over the next few years. These are the funds with the most substantial dividend reserve funds and those that have avoided the worst of the crisis so far.

Investment companies invested on the stock market can – and will – sometimes fall in value as well as rise, so investors must be prepared to take a long-term view for these to be appropriate. But the funds can be held inside your individual savings account allowance, providing tax-efficiency, as well as in pension plans, which may be useful if you’re trying to generate income for retirement.

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