With decreasing interest rates, why should investors consider investment companies?

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Following the Bank of England’s interest rate cut, David Prosser discusses where income seeking investors could be looking.

There aren’t too many certainties in the economic and investment outlook in the months ahead, following the UK’s Brexit vote in the European Union referendum. One sure thing, however, is that the climate for investors seeking income isn’t going to get any less hostile: although the Bank of England’s Monetary Policy Committee surprised many people by not cutting interest rates immediately in the aftermath of the referendum, it announced last week that it has now cut interest rates from 0.5 per cent to 0.25 percent. While this may not seem like a big cut to interest rates, don’t underestimate the impact of such reductions. For example, Royal Bank of Scotland has already indicated that it may have to start charging some customers to hold their money on deposit if rates go much lower.

So where does that leave income-seeking investors? Well, the case for considering investment companies, at least for those investors prepared to countenance the risk of their capital falling in value as well as rising, is getting stronger by the day.

Different asset classes

The first reason to look at investment companies is the broad range of asset classes on offer in the sector. That includes traditional and mainstream assets such as UK and international equities, where equity income funds offer attractive yields and have strong track records of delivering consistently rising dividends. But it also includes alternative assets such as infrastructure, debt and property.

These asset classes generate attractive yields but are often difficult for investors to access directly. They also tend to be illiquid – difficult to buy and sell quickly and affordably – which also presents a headache for most investors. An investment company structure, however, is uniquely well-suited to holding such assets. Collectively, investors have sufficient scale to buy these assets and since they invest by buying and selling shares in the fund, rather than the underlying asset, the illiquidity isn’t an issue either.

Different rules

The other big plus point with investment companies for income seekers is the rule book by which they operate. First, unlike other funds, investment companies can hold back some of the income they earn in good years in order to subsidise dividends paid to shareholders when times get tougher. Their dividend reserve funds are a crucial tool in ensuring they can pay consistently attractive – and often rising – incomes.

Also, subject to shareholder approval, investment companies are able to pay income to shareholders out of their capital profits. This has a downside – there will be less capital profits for the future – but for investors in need of income right now, it can be an important attribute.

For these reasons, many investment companies have an outstanding long-term record of paying attractive incomes to investors, even during the most difficult periods for markets. The Association of Investment Companies releases a list of ‘dividend heroes’ once a year, profiling the leaders – its most recent list included 20 funds that have raised their dividends in each and every year over the past 20 years. Heading the table is City of London, which has increased its dividend for 50 years. It is followed by Bankers Investment Trust and Alliance Trust, who have both raised their dividends for the past 49 years running. This isn’t a bad place to start looking for income in a low interest rate environment.

 

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