Market turbulence has thrown up good opportunities for people investing for income, writes Richard Sampson
While these are dark days for bankers, builders and the over-indebted, there are sparkling opportunities for income seekers and savers.
With one-year fixed-rate savings products paying up to 7 per cent, and the Government's preferred measure of inflation (CPI) running at 3 per cent, it seems that substantial real returns are easily available – without the need to look any further than the nearest cash-strapped bank. But as Martin Bamford, joint managing director at independent financial advisers Informed Choice, explains, income-hungry investors shouldn't get too complacent.
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"Cash is not a very sensible place to be for the long term, because there is no prospect for capital growth, and rising levels of price inflation will eat away at the value of cash over the long term."
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Yet all the gloom and uncertainty may still come in handy for the determined income seeker with an appetite for risk. That's because entire asset classes – from commercial property to small company shares and financial sector corporate bonds – have been savagely marked down over the last few months, often by 50 per cent or more. And since many of these assets also pay an income, which has tended to be stable so far, the fall in price has caused income levels to rise sharply. As a result, it is now possible to generate an attractive yield on a range of collective investments operating in these sectors.
While there's undoubtedly a risk of both further capital losses and a reduction in income if the economy really hits the skids, there's also the possibility of some capital growth when the economy recovers. And that could provide a useful measure of protection against inflation.
So if you're the kind of person who needs a high level of income, let's say around 6 per cent, should you be investing? And, if so, where should your cash be going? Tim Cockerill, head of research at IFA Rowan, said that a 6 per cent yield target is "setting the bar quite high", but he still comes up with a couple of intriguing ideas. First, he suggests investment trusts that invest in commercial property, including Foreign & Colonial Commercial Property and ISIS Property.
"Because these are closed-ended funds, they never had the big inflows of capital at the top of the market, so the managers never had to buy property with valuations on the high side. So what you're buying here are good managers, a good yield and a good discount."
But Cockerill cautions that investors who expect vacant "ghost offices" to become a much more common sight soon should look elsewhere, since high vacancy rates would mean a reduction in both the share price and the yield, as well as a widening of the funds' discounts to their net assets.
When it comes to corporate bonds, Cockerill is a believer, arguing that they offer "a rare opportunity to secure a good yield with the potential for some capital growth". And while he acknowledges that there is a risk of defaults, especially at the lower quality end of the range, he likes the fact that even a fund like New Star Extra High Yield typically holds around 175 bonds: "So even if a number do go pop, it won't materially impact the performance."
Cockerill suggests investors can further spread their risk by buying funds run by different managers and with different risk profiles, perhaps mixing the higher-risk New Star Fund with the Artemis Strategic Bond Fund and the Invesco Perpetual Corporate Bond Fund.
Ben Yearsley, investment manager at Hargreaves Lansdown, agrees that the diversified nature of a fund like New Star Extra High Yield mitigates the risk, although Yearsley is still a believer in good old income growth unit trusts, like Liontrust First Income.
"It's a pure equity fund, and so although the yield is under 5 per cent, the fund has a long-term track record and offers prospects of income and capital growth. If you want really high income you have to accept that there's very little chance of capital growth."
Nevertheless, for higher income seekers Yearsley suggests Invesco Perpetual Monthly Income, currently yielding around 7 per cent, which has an 80/20 bonds/ equities mix, with the equity element offering some growth potential.
He added: "It may be worth considering venture capital trusts (VCTs) on the secondary market. Recently, some have been on 50 per cent discounts to their net asset values, which has meant 50p shares have been yielding 5p a year in income, tax free. There are a number of consistent ones, including the Aberdeen Growth Opportunities and Aberdeen Growth VCTs, and they would also benefit if their discounts to net assets started to narrow."
The adventurous higher-rate tax-paying income seeker may be tempted by Yearsley's suggestion, and this kind of investor could also be attracted by high-yielding investment trusts such as Glasgow Income Trust, which is currently yielding just over 7 per cent.
Susan Anderson is senior investment manager at Aberdeen Asset Management, which manages Glasgow Income, and she claims the current turbulence presents some real opportunities.
"Take Marks & Spencer, which was yielding 5.7 per cent net of basic rate tax this week. It's not very often that an equity income fund gets the chance to buy into the retail sector, and despite the problems in that sector, M&S does have major property assets, which support its balance sheet."
Anderson adds that though she's confident that Glasgow Income should be able to maintain its income payouts, she does expect continued volatility when it comes to the share price, at least until the latter half of this year.
But it is Bamford who comes up with the most compelling argument for looking beyond the bank or building society. "The common-sense approach is to diversify by creating a portfolio that contains cash, fixed-interest securities, income-producing equities and property. Backing a single asset class in the search for income creates high levels of risk to your capital, and also the potential for disappointment if income levels are not sustainable."
