With UK interest rates languishing at 0.5 per cent and inflation running at 4 per cent and likely to rise this summer, what are the options for income-seeking investors?
At the top of the list is the UK equity income sector. Income funds offered relatively high dividends and lower volatility than many other equity funds for much of the last decade. However, the sector has fallen on tough times as a result of the savage dividend cuts in 2009 and in the banking stocks favoured by so many managers.
The sector was dealt a further blow last year as a result of the BP disaster in the Gulf of Mexico, which led to the UK’s highest income payer having to cancel its dividend.
However, things are looking up for the sector. BP has reinstated its dividend (albeit at a lower level) and analysts expect the UK stockmarket as a whole to enjoy double-digit dividend growth this year.
The downside of the UK stockmarket from an income perspective is that a large percentage of the overall dividend payout is produced by a handful of companies. But there are plenty of interesting opportunities further down the market-cap scale, including smaller companies.
There is also a place in income portfolios for global equity income. These funds offer diversification and reduce concentration risk but currency factors also come into play. They have performed well over the last three years due to sterling weakness and while the pound has few friends right now, sentiment can quickly change.
Within the fixed income world, gilts remain relatively unattractive, given the negative real yield on offer. In this current inflationary environment the index-linked market is worth exploring, albeit the sector remains expensive, with UK pension funds the dominant buyer.
There is selective value in corporate bonds but we have recently been reducing our exposure to sub-investmentgrade bonds with yields continuing to decline. However, good opportunities exist in floating rate issues.
Commercial property has been a long-standing favourite for income investors but the sector does not offer the same inflation-proofing benefits it once did. Closed-ended funds offer better opportunities than open-ended property funds, the former benefiting from higher dividends and trading below net asset value, the latter suffering from cash drag.
Statistics show we are living longer and with inflation in the spotlight, investors seeking income will look to funds that can grow their dividend, whether that be within a single asset class or the multi-manager/multi-asset area.
David Hambidge is investment director of pooled funds at Premier Asset Managers