'We may be close to the top of the UK interest rate cycle'

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The Independent Online

I am increasingly concerned about how investors should generate income these days. While my impression is people are becoming more used to the lower returns now available from bank and building society deposits, they have yet to fully grasp the fact that income from a whole range of investments has fallen quite sharply. Dividends on ordinary shares have been coming down steadily, with the yield on the FTSE Actuaries All-share Index not much above 2 per cent. For pension funds the situation is even worse, with the ability to reclaim tax on dividends being progressively withdrawn.

I am increasingly concerned about how investors should generate income these days. While my impression is people are becoming more used to the lower returns now available from bank and building society deposits, they have yet to fully grasp the fact that income from a whole range of investments has fallen quite sharply. Dividends on ordinary shares have been coming down steadily, with the yield on the FTSE Actuaries All-share Index not much above 2 per cent. For pension funds the situation is even worse, with the ability to reclaim tax on dividends being progressively withdrawn.

Then there are annuity rates. A combination of falling long gilt edge yields and greater individual longevity has led to returns that have halved over a decade.

The investment solution is far from straightforward. There are plenty of companies with returns that exceed those of long gilts, but the risk is either the dividend will be cut or capital performance will disappoint. If you look at the performance of higher yielding shares in the FTSE 350 Index compared with those in the bottom half of the yield table, you will find, even adding in the value of the dividend, you would have done better to stick with the lower yielders.

I was brought up in the Mr Micawber school of income planning. If you want 20 shillings of income in a year, then buy investments that deliver 20 shillings - at least. But to construct a portfolio with a yield of just 5 per cent these days can involve building in a higher degree of risk than used to be the case. Even with fixed income securities, returns tend to reflect a higher level of volatility than most investors want to accept. One fixed interest stock in which I was an investor fluctuated in price by around 25 per cent in a week not so long ago - at one stage yielding 14 per cent. Alarming or what?

There are corporate bond funds that provide an above average yield and, hopefully, reduce the level of risk with a broadly spread portfolio. Some of these make a virtue of buying securities that are likely to give a bumpy ride, pointing to the fact that the yield is likely to be secure. Old Mutual, on the other hand, is launching a corporate bond fund which aims to keep at least 80 per cent of the portfolio in investment grade bonds and achieve a portfolio return, net of expenses, of at least 6.7 per cent - hardly electrifying, but attractive given prevailing interest rates. Don't expect fireworks from the capital performance, although recent domestic rate hikes suggest we may be close to the top of the UK interest rate cycle.

Income seeking investors must accept anything other than a comparatively modest portfolio return will have to be met by spending capital. But if you want to at least bolster your spending money without adding unnecessarily to the level of risk, the Old Mutual Fund Managers Corporate Bond Fund looks a sensible bet.

Brian Tora is Chairman of the Greig Middleton Investment Strategy Committee

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