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Overseas sources fill the income generation gap

Brian Tora

With inflation coming in even more strongly last week, attention is increasingly being focused on when interest rates will rise. Sterling was in demand in the immediate aftermath of the announcement – a sure sign that currency speculators believe the Bank of England will be unable to stand out against these pressures for much longer. After all, these were the December numbers. The VAT rise has yet to be factored in.

Inflation is not just a worry here. In China, there are concerns that the cost of living is rising too fast although in reality their inflation is not vastly different to ours, if you take the RPI measure, that is. There are other countries facing inflationary pressures to, as energy and food prices escalate. The only beneficiaries of this global trend at present appear to be some of the commodity companies.

One side-effect of an uncertain inflationary outlook is greater currency volatility. This has been developing throughout the autumn, although sovereign debt worries have paid their part here as well.

Currency fluctuations are an important component of investment returns in the global marketplace in which we all operate these days. Factoring in how foreign exchange movements might contribute to the overall investment experience is one of the hardest tasks for any portfolio manager.

Here in the UK, the argument goes that the bulk of the constituent companies of our leading index derive a significant proportion of their revenue from overseas, making the FTSE 100 index a valuable hedge against the vagaries of sterling. Would that it were that simple, although it has to be admitted that a number of companies operate wholly outside the UK in the resource sectors.

But it is in the area of income generation that overseas investment is now beginning to play an important role. With the banks and BP largely dropping out of the dividend provision stakes, managers are having to look elsewhere to find reliable sources of income.

Both Asia and Latin America have been cited as potential rising income providers. Even Japan is playing a role here now.

UK equity income was once the core sector for many portfolios, with a reputation for delivering a better total return over the longer term than virtually any other. The managers here have had a particularly tough time over the past few years but alternative sectors for income provision – such as corporate bonds – now appear under threat from rising inflation. Diversifying your sources of income makes good sense these days.

Interestingly, it is in the closed-ended part of the investment vehicle universe that some of the most inter-esting opportunities appear to lie. In part, this is because investment trusts can oper-ate revenue reserves – putting aside income to even out later distributions. This has allowed some trusts to demonstrate a progressive dividend pay-out policy over many years.

And in the field of overseas income generation, this could prove an important extra tool to have in your box as a manager.

But while wealth managers are regular users of closedended funds, IFAs have been slow to embrace them in the past. Cynically, some have said this is because investment trusts do not pay commission, although the RDR should level the playing field on this score.

Perhaps more important is ease of access. Wealth managers can use stockmarkets but few platform providers include invest-ment trusts among their range of tradable products. It seems to me that a case exists for easier access to what could become a more important vehicle for the clients of advisers after the RDR comes into effect.

Brian Tora is a consultant to investment managers JM Finn & Co

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