Where to invest for income in a low interest rate world

 In Finance & Investments

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INVEST FOR INCOME IN A LOW INTEREST RATE WORLD

Trustees with an obligation to generate an income for entitled beneficiaries have customarily been able to pick from National Savings products and gilts at the bottom of the risk range, cash deposits for liquidity and to buffer fluctuations in capital prices, corporate bonds or structured products and equity income shares where some volatility of capital values over the shorter term is acceptable.

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However, as central bank and Government policy is shaped to deal with the current financial crisis and developing recession in the UK, we find ourselves looking at interest rates on deposit funds at lifetime lows and the yield on gilts suppressed by “quantitive easing” to a level that even the Victorians might have found unacceptable.

Having your money “in the 3 per cents” like a character from Austen or Trollope is only an attractive option if you believe inflation is gone for good. That is not likely to be the case in our view, and the view of markets if one is to believe the recent take up of index linked stock, is that inflation will be back with a vengeance in maybe as little as 2 years time.

What can trustees do to secure a reasonable income?

Options include:

  • Corporate Bond portfolios or funds with a choice of various risk levels
  • Portfolios or managed funds of high yielding equity shares
  • “Designer” income yielding structured products with capital “guarantees” of varying quality
  • Commercial property investment, via collective funds for all except the largest trust funds

All the above will yield more income than cash deposits at present, although in most cases it will be in a fully taxable form, with the ultimate tax payable according to the form of the trust and status of the ultimate beneficiary. Some trusts will be able to use life assurance bonds to defer any tax and simplify administration, but it should be borne in mind that most life assurance bonds do not pay a true income, withdrawals being technically of capital even though gains are subject to a form of income tax under the Chargeable Events rules.

Diversification

As always, diversification of both asset types and asset managers is well worth considering. Commercial property is offering very good yields at present but capital values may slide further before picking up. Corporate bonds issued by the less credit worthy companies are paying very good interest but there is the corresponding risk of not getting your coupon, or even not getting your capital back. Structured products may seem to offer the best of everything – high income and capital returned unless there is a near complete meltdown, but there will usually be a heavy expenses loading and the investor must understand how the product returns are being delivered and who the various counter parties are.

Equities

Strange though it may seem, the least risky investment over the medium term of 5 to 15 years is arguably a well diversified fund of equity income shares chosen by a good stockbroker or collective fund manager. There are some very cheap shares in the market at the moment and although dividends may well be cut or even missed by many companies this year, some current yields are so high that it is almost inconceivable that yields from a portfolio of equities in the right market sectors will not beat returns from cash and gilts over 2009. And you might even get a capital gain if you wait until mid 2010!

Of course, trustees need to take professional advice and ensure that any investments are carefully matched to their risk preference, investment time horizon and liquidity requirements.

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