An encouraging outlook for the UK economy and stock market - fund managers are forecasting dividend growth of 6 per cent to 9 per cent this year - suggests plain equities could perform handsomely. So what should investors wanting income do?
The answer depends to a large extent on how desperate investors are for income now, rather than for future income and capital growth, and how they view risk.
Yields well above stock market average - presently 4 per cent - can spell danger of capital erosion in the long term.
Investors should consider when comparing estimated yields: what the prospects are over the years for a rising yield; whether the yield is quoted before or after PEP charges and on the launch price or existing price of units; whether PEP charges are taken out of capital; and whether the payout is monthly, quarterly or half yearly?
There are several ways of achieving high income.
The Henderson Touche Remnant Accelerated Income PEP is the PEP version of a new split-capital investment trust, HTR Income and Growth Split Trust. The income shares will appeal more to PEP investors than the zero dividend preference shares, which only offer capital gain. The PEP's estimated starting yield is 7.5 per cent, with scope for income and capital growth. Risk of capital erosion arises if compound growth on the underlying portfolio falls below 5.75 per cent per annum and if companies fail to increase their dividends as expected.
Guinness Flight's Income Share Trust adopts a "fund of funds" approach and invests in income shares of split-capital trusts. It estimates annual yield of 7.9 per cent.
The GT Income Fund invests in UK equities and, sometimes, equity convertibles. It has generated substantial income and capital growth over time. An investment of £1,000 at the fund's launch 21 years ago, with income reinvested, would now be worth £23,269, compared with £4,652 deposited in a building society. The starting yield is around 4.5 per cent.
Investors wanting high yields now rather than in the future have been tempted over the past two years by PEPS which maintain yields through the use of financial derivatives, including share options. Not all have performed as hoped. Hypo Foreign & Colonial's Higher Income Plan, launched in February 1993, was the first Pep aiming to produce an estimated yield of 10 per cent by using financial derivatives, high yielding bonds and encashment of capital. In its first year it was criticised for losing out on capital growth in a buoyant stock market. In the past year the units have dropped in price. The selling price is now 20.75p - 17 per cent below the 25p launch price - and the buying price is 12 per cent below. The yield was cut last spring to 9 per cent.
Craig Waltong, marketing direc-tor of Hypo F&C, says critics misunderstand the plan. Investors needing high and ready income were prepared to forego capital gain in the good times and have benefited from the fund's defensive qualities in a falling market.
Graham Kane, managing director of Morgan Grenfell Investment Funds, says many of the firm's investors have holdings in its High Income Trust and the High Income and Growth Plan, which produces a lower yield and greater capital gain.