Inflation-proof a regular income

Inflation-proof a regular income

Inflation is bad news for investors: back in the 1970s, when inflation was rampant, investors lost money on shares, gilts and cash deposits. According to Barclays Capital, the average real return – that is, after inflation – on government gilts over the decade was -4.1 per cent. It was 2.8 per cent for a building society account and -2.3 per cent for equities.

These figures include any income from these investments, which makes the returns all the more dismal. In simple terms, the figures mean investors in shares, gilts and cash deposits ended the decade worse off: the real value of £100 invested in equities at the start of the decade was just £79 by the end. Other assets would have fallen in value even more.

Could we be in the middle of an equally unrewarding period? Inflation, measured by the Consumer Prices Index, may be well above the 2 per cent target but, at 5.2 per cent in September, it is still well below the level of the 1970s, when it peaked at 25 per cent and averaged 13 per cent. Then, however, the government fought inflation with high interest rates – they were above 10 per cent for most of the decade and reached a high of 17 per cent in 1979 – so savers received a generous income from their cash balances, even if it didn’t keep up with inflation.

Today interest rates have been at a record low of 0.5 per cent since spring 2009 and, given that the economic outlook is getting worse rather than better, they are unlikely to rise any time soon. This has left income seekers struggling to get a half-decent return, never mind one above inflation. Moneyfacts estimates that the average easy-access savings account pays just 0.94 per cent, so anyone with money in those is instantly losing more than 4.2 per cent of their deposit’s value in real terms. It adds that no regular accounts beat inflation in today’s markets – the only products that do are five inflation-linked bonds.

Income seekers must look elsewhere for decent returns. However, the alternatives come with the risk that capital will be eroded.

In our portfolio of alternatives we recommend funds and trusts that offer the best combination of income and capital preservation. While the yields on some recommendations are below the level of inflation, their yields should grow over time, and the evidence is that income growth is more important than high yield in producing a good return.

Equity income funds and investment trusts

Equities have long been seen as one of the best hedges against inflation – they were the best performers in the 1970s, although they still lost money. Tim Cockerill, head of collectives research at Rowan Dartington, says: ‘Over the past 12 months, the average dividend among FTSE 100 companies has been increased by 9.7 per cent, while inflation has been at 4.5 per cent, which illustrates how equities can offer real income growth.’

The recent stock market volatility makes Brian Dennehy, managing director of Dennehy Weller, think investors should not be too focused on the capital value and volatility of shares, at least in the short term. He says: ‘I would rather look at the capital value as the heart of the investment, which is pumping out a regular income.’

Artemis Income is a favourite among advisers. Cockerill points out that, over the past decade, its total return has been 90 per cent, of which about 60 per cent has come from income growth and the remainder from capital growth. Inflation over the period was around 30 per cent.

One of Neil Woodford’s funds should be part of any income portfolio. His yields are never the most generous, but in more than two decades as a fund manager, he has demonstrated his ability to produce top-quartile returns whatever the state of the economy and the markets. His Edinburgh Investment Trust has beaten his Invesco Perpetual Income and High Income funds over one and three years and has a total expense ratio of about 0.4 per cent, a quarter of that on the unit trusts. What’s more, investors can buy into the trust at a discount, albeit a tiny one.

Temple Bar Investment Trust, managed by the much-admired Alastair Mundy, has an even more impressive record than Woodford’s Edinburgh trust. The trust’s dividend has increased for 27 consecutive years and grown by 37 per cent over the past decade.

Investors should include overseas income funds as part of their portfolio for two reasons. First, dividends in the UK stock market are increasingly concentrated in just a few sectors, so looking overseas can aid diversification. Second, emerging markets are in a far better economic position than developed markets, so choosing an income fund in this area should offer better prospects for capital growth.

Newton Asian Income has an attractive yield of 5.67 per cent, above the level of both the CPI and the Retail Prices Index, and an impressive growth record: it has returned more than 97 per cent over the past 10 years.

Stuart Rhodes’ M&G Global Dividend fund has a lower yield, at 3.46 per cent, but in the three years the fund has been going, he has established a good record through his strategy of looking for companies with consistently good, rather than simply high, dividends.

Fixed income

Patrick Connolly, head of communications at AWD Chase de Vere, says: ‘Most income investors should have a significant weighting in fixed-interest investments. These can provide steady interest and are far more secure than equities.’ But he adds: ‘It is extremely difficult to invest in the most secure forms of fixed interest and still yield as much as the rate of inflation. There are no gilt investments that yield this much and many investment-grade corporate bond funds don’t either.’

That reflects the unease among investors, who have fled into the relative safety of government bonds. There is also the risk that, when confidence eventually returns and investors are willing to look elsewhere for returns, anyone holding gilts could face a capital loss as prices fall.

Dennehy says: ‘Index-linked (government) gilts should be a useful hedge, but the issue is, when you come to sell them, they can be under- or over-priced.’

An M&G bond fund is an essential part of an income portfolio. It launched an inflation-linked bond last year, but it yields less than 2 per cent and has yet to establish a lengthy track record. Instead, we are opting for M&G Optimal Income, with a yield of just over 4 per cent, which has a flexible mandate that allows manager Richard Woolnough to invest across the range of bonds.  

We compensate for the below-inflation yield on that fund with the Invesco Perpetual Corporate Bond fund, highlighted by Connolly as the one investment-grade fund with a portfolio yield that’s higher than inflation – 5.34 per cent. Paul Read and Paul Causer at Invesco Perpetual have a well-deserved reputation for getting top performance from their many corporate bond portfolios.

Bricks and mortar - solid yield and long experience

Property has traditionally been a hedge against inflation but, in the UK at least, prices of top-quality offices have already risen sharply, pushing yields down, while the poor outlook for consumer spending, which has already sent a number of retailers into receivership, means retail property does not look attractive.

One fund that offers a reasonable yield together with a manager experienced in getting the best out of difficult markets is Threadneedle UK Property, where manager Don Jordison is skilled at spotting special situations. He has bought in London’s Mayfair – a highly sought-after area – and an airfield near Chelmsford, where aggregates company Hanson is paying rent equal to a 9 per cent yield to extract gravel.

Our regular income portfolio aims to slay inflation

NamePrice (p)Net yield (%)Dividend datesAmount investedReturn on £100 invested after: 1 year3 years7 years
Artemis Income150.74.6December, June£10,00098.1111.7144.4
Edinburgh Investment Trust448.74.6July, February, May, November£10,000113.2149.5191.5
Temple Bar IT832.04.6September, March£10,000110.0154.4178.8
Newton Asian Income150.55.7February, May, August, November£10,000105.2169.4
M&G Global Dividend120.63.6February, May, August, November£10,00099.4127.0
M&G Optimal Income120.03.6May, November£20,000101.1134.5
Invesco Perpetual Corporate Bond136.84.3June, December£20,00094.1121.0124.5
Threadneedle UK Property Trust89.23.7January, July£10,000102.097.3

Source: AIC/Lipper as at 1 October. Performance figures are with net income reinvested, The quoted yield for open-ended funds is Lipper's projected yield figure.

Subscribe to Money Observer magazine



Inflation-proof a regular income

An interesting and helpful article but why no mention of trackers? There are some good examples that produce yields of c. 5.0% with very low TERs. By comparison, although Edinburgh Investment Trust undoubtedly has an enviable record, some sources suggest that its TER is currently nearer 0.8%.than 0.4%. And most of the funds you highlight have TERs in excess of 1.5%.

Post new comment

The content of this field is kept private and will not be shown publicly.
By submitting this form, you accept the Mollom privacy policy.