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Where can you find income when markets are volatile?

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22 January 2016

David Prosser looks at where income seekers could find opportunities during leaner times.

Life just gets tougher for investors seeking income. Many had hoped that the turn of the new year would see the Bank of England’s Monetary Policy Committee move decisively towards interest rate rises, almost eight years after cutting rates to almost nothing. So much for that – Mark Carney, the Bank’s Governor, could not have been clearer this week with his message: rates aren’t going anywhere soon.

It gets worse, however. Last year, income-seeking investors prepared to take some risk with their investments were at least able to find yield on offer in the stock market. In fact, 2015 was a bumper year for dividends in the UK stock market, with banks returning to income pay-outs and several companies paying special dividends following M&A or other transactions.

Now, however, dividends are under threat. Plunging commodity prices have already prompted companies such as Anglo American and Glencore to pare back their dividends. But the natural resources sector may not be the only area where pay-outs are under threat – the competitive landscape of the supermarket industry, for example, is putting these businesses under pressure. Insurers are feeling the strain of volatile investment markets. Some banks, too, may be forced to act.

The outlook is therefore bleak for income seekers. Not only is there little hope of respite from super-low interest rates, but also, other sources of yield are drying up.

Enter the investment company sector, whose unique advantages shine out in this low-income environment. Most importantly, closed-ended funds are allowed to build up income reserve funds – to hold back income in good years for pay-outs from their investments in order to subsidise dividend payments to shareholders in leaner times.

That may prove to be a hugely valuable feature during the year to come, which looks set to be one of those leaner periods. Investment trusts with reserves buoyed up by bumper pay-outs in 2015 will be able to maintain and even increase their own dividends.

You can see the effect by looking at the long-term record of income-producing investment companies. There are now 10 funds that have increased their dividend in every single year over the last 40 years – City of London Investment Trust is actually closing in on its 50th consecutive year of increased pay-outs, while Bankers Investment Trust has just reached its 49th consecutive year of dividend rises – and a further five whose track record of doing so goes back at least three decades.

It helps that investment companies have another tool at their disposal in addition to being able to build up reserves. They are also entitled to subsidise dividend payments from capital profits, where the board deems it necessary. This means that even trusts investing in low-yielding assets may still be able to offer an attractive income stream.

So where are the income-producing investment companies to be found? Well, in a note published this week by the investment company team at Stifel Funds, Iain Scouller and Maarten Freeriks point to more than 20 funds with portfolios invested in equities that are currently offering a yield above 4 per cent, as well as further opportunities in other asset classes.

“We calculate there are 21 trusts with market capitalisations in excess of £80m investing in equities which have a yield of 4 per cent or higher,” say Scouller and Freeriks. “For investors prepared to take equity risk, these may be attractive at a time of exceptionally low interest rates – and in non-equity sectors, the property, infrastructure, renewable energy and debt fund sectors also continue to offer attractive yields.”

For investors seeking income, it seems, the investment company industry continues to offer choices that are sorely lacking elsewhere.