Bargain hunt

Forget Black Friday. If it is real bargains that you’re after, the investment companies sector might just be the best place to look right now. The average fund in the sector was offering a yield of 5.2% on 31 October, the highest month-end figure recorded in this century so far – not bad in a marketplace where income has collapsed as companies worldwide have slashed their dividends.

What is going on here? Well, a yield, of course, is a product of two factors: it is the income that a share offers divided by the price of that share. And on both sides of the equation, there is an interesting tale to tell.

Let’s consider income first, where investment companies have some natural advantages. First, this is a well-diversified sector: at an aggregate level, the sector’s yield is delivered by asset classes ranging from infrastructure to debt finance, as well as the equity market, which has helped mitigate problems in the latter.

Also, investment companies have the unique ability to build up dividend reserve funds, retaining some earned income in stronger years in order to bolster pay-outs in tougher times. They also have the option, subject to shareholder approval, of paying income from capital.

These advantages have enabled the vast majority of investment companies to maintain or even increase their dividends this year despite the problems caused by the Covid-19 pandemic. Fewer than one in five investment companies have had to reduce their pay-outs.

On the other side of the equation, lower investment company share prices have also contributed to the spike in yields we are now seeing. Every investment vehicle, including investment companies, saw the value of its portfolio suffer as markets were hit by the pandemic, particularly during the Spring. Investment company share prices fell accordingly – and in some cases by more than the underlying value of the portfolio, as the shares slipped to wider discounts to net asset value.

In summary then, the record yields we now see in the investment companies sector reflect the fact that funds have been able to maintain or even increase their dividends during a period when their share prices have fallen. It has been a classic double whammy effect.

All of which brings us back to bargain hunting and Black Friday. As savvy shoppers know, the cheap deals on offer from the latter are invariably artificial; retailers have a habit of raising their prices ahead of the big day so they can cut them later on and claim to be offering great value. The deals on offer today in the investment companies sector, by contrast, are much more genuine, even if they have been created by unusual market circumstances.

Historically high yields of this type are sending one of two signals. It may be that investors simply do not believe that investment companies will be able to sustain their pay-outs. Alternatively, they may not feel quite ready to back world markets to recover from the chaos of this year.

The pessimists should not be dismissed. While there is plenty of good analysis suggesting many investment companies are well-placed to maintain dividends, downside risk remains elevated in these volatile times. However, if you’re in the latter camp – nervous about the future but buoyed by the emergence of Covid-19 vaccines perhaps - there’s every reason to go looking for good deals in the investment companies sector. These generous yields won’t stick around forever.