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The Income Outcome

In the wake of the credit crunch, all the key traditional income areas need extra care right now – equities face dividend cuts, defaults rising for corporate debt, inflation risks for government bonds as well as tenant delinquencies and gearing issues for property and negligible rates on deposits.

The table below shows the comparable average yields for key IMA income sectors at 30 June 2009:

IMA Cautious Managed 3.1% average
IMA Global Bonds 3.5% average
IMA UK Equity Income 5.5% average
IMA £ Corporate Bonds 4.7% average
IMA Strategic Bonds 5.3% average

And yet the majority of investors require an income return from their investments. What to do in these tough times?

‘Doing a Carnival’

Colin Morton of Rensburg UK Equity Income describes the new habit of unexpectedly passing a dividend completely as ‘doing a Carnival’ – a reference to one of the first companies to decide it was bad practice to give shareholders a 6% yield and then have to borrow in the corporate bond market at above 10%. The maths doesn’t add up. Then of course there are the more obvious reasons for cutting dividends such as economic hardship – resources companies were putting 30% dividend increases through nine months ago and now pay out nothing at all.

Using active, nimble managers with good analytical skills can help get around these issues, as can diversifying your equity income exposure within the UK and into overseas markets where dividend growth rates are higher and in some cases yields are comparable.

Do not a lender be?

It’s also time to take particular care in the fixed income markets. The unnerving flows into corporate debt funds are so far proving to be something of a siren call. The lure of yields well above plummeting cash rates appear to overwhelm the rocky issues of rising defaults, enormous issuance and our particular current concern of illiquidity in corporate bond markets. Some bond fund managers are threatening in specie transfers in lieu of cash for redeemers and yet the money flows in. In fact corporate bonds have lost you money on average this year even allowing for their superior income. Of course these are sweeping generalisations and we do have exposure to the bond arenas but suggest fund liquidity is checked regularly, and we favour specialist niche funds with superior knowledge over generalists, and/or flexible mandates.

Safe as houses

Property has traditionally been a yield investment until being turned into a debt fuelled capital growth alternative to equities over the last few years. The subsequent fall from grace has been precipitous. Huge challenges remain for the sector which in commercial and residential terms is at the epicentre of the downturn. However there are niche areas where value is exposed by the wholesale rejection, such as a Caravan Park fund where bookings this year are up hugely, and a fund specialising in doctors’ surgeries where the government pays the rent and competition for tenants is virtually non-existent.

So tread carefully in the income sectors at present amongst the relatively attractive headline yields and use an extra element of common sense. This is what we try to do every day with our Distribution fund investment management work.

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