POWERING OPPORTUNITY

ALASTAIR POWER | INVESTMENT RESEARCH MANAGER

In the wake of the Global Financial Crisis and the subsequent near zero interest rate environment of many Western economies, income investors faced a difficult time in their hunt for income. Many traditional investments like retirement annuities and government bonds soon became unattractive in their returns. Some investors subsequently moved into riskier areas of the financial markets to generate their income, while others adopted the swathe of new alternative investment strategies offered by asset managers. In this issue, we explore the moves taken by investors to generate income in a near zero interest rate world, the importance of a growing yield, generating sustainable incomes through renewables and some of the fund structures on offer in the market.

Following interest rate increases, many may be attracted to 4% cash ISA rates, raising the question of why enter the financial markets for a similar yield but exposure to volatility? On a simple yield comparison of 4% in the safety of a bank or a 4% dividend paying company, choosing the former is fair. But what if the dividend payment is growing at 5%? On a £1,000 pot, the 4% in the bank would generate £40 of income and payback the initial £1,000 of capital in 25 years. That same pot invested in a 4% yield growing at 5% would generate £40 of income in the first year, but through growth of income would pay initial capital back in 17-years, leaving the investor holding the asset and a yield on initial investment of 9.2% at that 17-year payback point. When broken down in this manner, the income growth rate is undeniably a powerful tool over the long run but requires alignment with risk levels and investment time horizon. The pros and cons of focusing on dividend growth and high yield are explored later.

Renewable investing has experienced exponential growth in recent times, attracting significant investment from institutions and governments. Retail investors have access to these assets and we explore some of the windfocused power generation strategies on offer that enable access to sustainable and diversified income streams. Multiple streams of revenue underpin the returns of wind turbines that have enabled two of the listed investment vehicles to announce dividend increases in-line with inflation in recent months.

Many retail client portfolios display the similar trait in having a mix of direct positions in equities and bonds alongside positions in collectives, either open or closed-end structures. Within Collective Investment Schemes (CIS), different structures have their own pros and cons for income-focused strategies. While open-end funds are required to distribute all their generated income and provide ample liquidity to meet redemptions, closed-end funds have an edge, able to hold illiquid assets and retain dividend reserves to enable the smoothing of income distributions over time. In this edition, we’ll have a quick look at some of the strings able to be pulled within the closed-end investment trust structure, the benefits, and the drawbacks.

With interest rates expected to plateau in 2023, asset prices are reasonably expected to stabilise as investors begin to assess the impact of higher interest rates on corporate profitability. The volatility experienced through the last calendar year has presented opportunities for income investors looking for yields at a bargain. If prepared to withstand some volatility, high quality growing revenue streams are currently on sale.