Shares income can shelter savings from inflation peril

INCOME has long been considered the Holy Grail of investing, and never more than now as inflation-hit savers increasingly turn to equities.

Yet while hundreds of funds and trusts promise to pay a regular income, tracking down those that really do over the long run is the challenge facing investors.

Inflation and low interest rates have had a devastating impact on cash savings over the last two years, and with the Bank of England likely to leave the base rate at 0.5 per cent for some time, the hunt for income will only intensify.

And if we’re facing a decade of low growth, as many economists believe, dividends will come to play an even bigger role in total returns than they do now. The challenge for investors is to source those dividends without taking more risk than they can handle.

Alan Steel, chairman of Alan Steel Asset Management, said: “A lot of people are holding onto cash Isas because they regard them as low-risk investments, but with most Isas paying less than 1 per cent they are losing money. The best thing they can do is swap their cash Isa for a portfolio of income funds and get income of 5 per cent a month,” said Steel.

“It’s the best defence – income funds can protect your wealth while kicking out a nice regular income,” he added.

That dividends are the biggest single component of investment returns, especially when reinvested year after year, is frequently overlooked. It is estimated that over any ten-year period, dividends account for at least 40 per cent of total returns from equities. During low-growth periods, that proportion can double.

The good news is that plenty of investment trusts and unit trusts are regularly paying above-average yields.

One in three investment trusts currently pays income of more than 3.2 per cent, above the FTSE 100’s average yield, according to new figures from the Association of Investment Companies (AIC). Trusts in the property, UK and global income sectors are averaging dividend yields above 5 per cent a year, it revealed.

Annabel Brodie-Smith, communications director at the AIC, said: “The investment company sector has long recognised the importance of dividends and it’s encouraging to see such a significant proportion of the sector yielding more than the FTSE 100 annual average.”

Investment trusts can maintain dividends regardless of market movements, as they can keep back reserves during the good years to ensure they can pay out during more turbulent times.

The top 40 investment trusts at least match the 4.7 per cent return currently paid by the most competitive cash option available, the top-paying five-year fixed rate bond.

The average property trust is producing a dividend of 7 per cent, with the Standard Life Investments Property Income trust among the top performers, at 7.8 per cent. With a discount of 8.2 per cent, the trust is among many with shares priced below the value of their holdings.

The next-best sector for yield seekers is UK high income, where trusts are averaging dividends of 6.6 per cent. The global high income and infrastructure sectors also average above 5 per cent.

In all, 34 trusts currently pay dividend yields of 5 per cent or above, with another two dozen yielding above 4 per cent.

Tom Munro, owner of Tom Munro Financial Solutions in Larbert, said: “In the search for a higher income yield for clients, I have found value in several investment trusts yielding in excess of 5 per cent while maintaining reasonably strong capital growth over the medium to long term.

“With a current yield of 5.46 per cent, the Henderson High Income Trust is a good example of not only meeting income needs but also long-term capital appreciation, as it has returned just short of 51 per cent over the past three years.”

But do your homework and look beyond yield when picking an income trust. Brodie-Smith said: “Investors need to consider their risk profile when making an investment decision, and if investors are in any doubt they should consult a financial adviser.”

Trusts aren’t alone in providing a consistent income. Hundreds of unit trusts or open-ended investment companies (OEICs) pay a regular income, including more than 100 in the UK equity income sector alone. And while that means the onus is on investors (or their advisers) to pick out the top funds – checking performance at websites such as www.iii.co.uk or www.trustnet.com – Steel believes there is as much value in income funds now as at any time in the last 25 to 30 years.

“Income funds such as those run by Rathbone, Invesco Perpetual and Neptune are all paying monthly dividends of 4 per cent or above, and with the prospect of rising income year after year.”

With the promise of both capital growth and consistent income, UK equity income funds are popular with UK investors. They vary widely in terms of approach and performance, with a considerable gap between the best and the worst in the market.

High income funds – which prioritise income, as the name suggests – are currently paying yields of up to 8 per cent, with the Newton Higher Income and Marlborough UK Equity Income funds among those paying above 7 per cent.

Ben Seager-Scott, senior research analyst at Bestinvest, emphasises the importance of finding a good fund manager.

“Investors should look for managers avoiding getting sucked into the trap of taking a lot of exposure in the highly concentrated income region at the top of the FTSE 100, which can leave portfolios vulnerable to black swan events such as last year’s BP oil disaster.”

The sector houses some of the UK’s most popular funds, not least the Invesco Perpetual Income and High Income funds run by Neil Woodford (who also manages the Edinburgh Investment Trust), and the Artemis Income helmed by Adrian Frost.

The latter is able to invest up to 20 per cent in non-UK companies, and that global appeal has changed the face of income investing in recent years.

As growth in developing economies continues to outstrip that in the developed world, more funds now specialise in finding income from companies around the globe.

One example is the M&G Global Dividends fund, which aims to invest in the world’s top dividend-paying companies. “Companies must have 25 years of increasing dividends just to qualify for consideration for inclusion in the fund,” said Steel.

He also likes the Newton Global High Income and the Invesco Perpetual Global Equity Income funds.

The Asia-Pacific region currently boasts some of the most attractive income opportunities around, according to Seager-Scott.

“What many investors don’t know is that this region accounts for the highest proportion of decently yielding stocks in the world,” he said. “A manager we rate in this area is Jason Pidcock of Newton’s Asian Income fund, which favours investment in the more developed parts of the region such as Australia and Singapore and has a very attractive yield right now of 6.1 per cent.”