Seeking income during a recession

Early in August, Moneywise hosted a live webchat with investment experts Neil Dwane, manager of the Allianz RCM European Equity Income Fund, and Andy Parsons, Advice team manager at The Share Centre, for to discuss how people can achieve – and keep hold of – a sustainable income.

Thank you to everyone who joined in and asked questions. Here are the responses:

Q: What does investing for income actually mean?

Andy Parsons (AP): Fundamentally, there are three avenues people will look for income: cash deposits; gilts and bonds; equity income from shares. These three strategies all have a varying degree of risk. So, with cash deposits - these have been heavily under the spotlight due to low interest rates whereas bonds (such as corporate bonds) have received much publicity as a potential alternative, albeit, they carry a higher degree of risk. Advice should be sought before any investment.

Neil Dwane (ND): Equity income remains a very robust and popular investment strategy for UK investors. This route offers investors the potential to receive dividends (income) according to the amount of equity (typically, shares) they hold.

I would note that there have been recent media concerns that UK equity income is very reliant on dividends from oil and telecoms and thus investors should consider looking at broader sources of income, for example, from European companies as well. Again, advice should be sought before any investment.

Q: How do I maximise income. Where is your private money invested at the moment?

AP: I am firm believer in that any portfolio for income and growth should be well diversified in terms of geographical representation (not solely UK) and asset class (so, cash, gilts, bonds and equities).

ND: The largest asset people own is their property and it is also one of the most tax efficient. Therefore, I think you could consider further investment in residential property where you get tax benefits on the interest and additional income from the tenant.

AP: Any investment, of course, must be considered against a personal attitude towards risk and investment objective.   

Q: Which are best for income over a sustained time - income funds or income from bonds?

ND: History clearly demonstrates over the long-term that investing in equities and re-investing the dividends produces the best returns to investors. While bonds have in recent times yielded more than equities, they clearly do not do so at this time and will not offer growing income as the global economy recovers.

Q: I've seen conflicting advice about investing in tracker funds - some say it's the only way forward, others that it's a recipe for disaster in the present climate. What do you think? Is a tracker for the FTSE 250 indeed more profitable than for the FTSE 100?

AP: There has been much speculation as to whether a tracker fund is likely to be more profitable than an actively managed fund. A key point to note is that a tracker fund at best will only match the performance of an index, whereas an actively managed fund will look to outperform the market although this cannot be guaranteed.

ND: I believe trackers offer a lower cost route to exposure to equity and other markets. However, as we have seen in the last two years a tracker fund has mirrored an index, which could be full of companies that could subsequently collapse in value like many of the UK banks. And thus, may not be as effective an investment vehicle for investors.

Q: I have taken £10,000 out on various credit cards so I can invest in the market - what would be the best funds to make profit on at the moment?

AP: Any investor who considers this approach would need to appreciate this is a high-risk strategy due to the fact that the investment return would need to exceed the interest rate on the credit card. Personally, this is a strategy I would not recommend.

Q: Do you agree with the buy and hold strategy for selective blue chips?

AP: Whenever investing in equities, an investor should always have a pre-determined price target in mind for selling whether for a profit or potential loss. Investors should never shy away from potentially locking in profitable gains and buying back in again on share price weakness. It is far too easy to continually hold and see gains suddenly wiped out. Many stockbrokers now allow investors to set triggers such as ‘alerts’ or ‘tracking stop losses or ‘stop loss limits’ to help lock in potential profits or help minimize any potential losses.

ND: I personally agree with this statement, that a substantial proportion of someone's equity holdings should be investing for the longer term in high quality, well-managed companies. Warren Buffett has done it successfully for many years!

Q: My shares have dropped 25% since last year. Should I sell them and buy government bonds or hold on until I need the money in four to five years’ time?

ND: While I can't give you specific advice, I would suggest four to five years’ investment time proviso is long enough to allow a well-managed, well-placed company to recoup your losses. Obviously you need to satisfy yourself that your investment is capable of generating future profits growth that will be rewarded with a higher share price.

The alternative of investing in bonds at this time over the next five years will be to a large extent determined by both the size of the UK government deficit and the threat of inflation in that period. So, I would personally stick with the equities.

Q: Would you recommend investing in corporate bonds for income?

AP: This is an area of investment that has received much publicity over the past six to nine months. Any potential investor should be aware that a corporate bond is essentially an IOU from the company and need to consider whether that company will be able to repay the debt. Also, bonds are rated by the various agencies as being either ‘investment grade’ or ‘non-investment grade’. Those rated ‘non-investment grade’ generally offer the highest potential return but also carry the greatest risk of default.

ND: I would like to add that, in many cases, the yield from a corporate bond of a company will be significantly less than from a share or equity of that company. Clearly, this reflects the greater certainty of the interest being paid. However, in the case of strong companies, like BP or Royal Dutch Shell, there remains at the moment there is little doubt that the dividend will be honoured and thus, why buy the corporate bond when you can buy the equity with all the attractions on it?

A: Most of my money is in UK equity funds. Is there anywhere else I should consider putting?

ND: My personal view is that the UK and the US markets will be the weakest performers in the next couple of years as the economies recover from the credit crisis and the extended housing markets. Thus, I believe investments into Europe (where there are stronger fundamentals such as exports and closer access to the CEE region for example) as well as into Asia (where the global theme of industrialisation and urbanisation will continue to accelerate) are certainly areas in which you may want - having taken further advice - to consider investing.

Q:  There is mounting speculation that the American economy will collapse as early as September due to various countries around the world dumping the dollar. Could you speculate what impact this would have on the British and world economy, particularly the stockmarkets, if this were to happen?

ND: The Federal Reserve and the Bank of England reports both highlight that the economies remain in a very fragile condition. Therefore if the emerging recovery stalls there will be further need for fiscal action to re-sustain the economies. I think it fair to conclude that further fiscal action from either government will lead to weakness in sterling and the US dollar.

Overseas investors remain significant holders of US debt and thus they would be very sensitive to a significant weakening of the US dollar - but in reality the US dollar remains the global currency of choice at this time.

Q: I've been seeing a lot of news about UK companies cutting their dividends. Should I be concerned about this?

ND: During any recession, there are always weaker parts of the economy that are unable to generate sufficient returns to pay their shareholders a dividend. This is, unfortunately, a normal part of the cycle and has been exasperated by corporate leverage and by the share buy-back of the last five years.

Strong companies with good business models are increasing their dividends. European companies currently yield a higher level of dividend than the UK and thus investors could consider moving some of their portfolio towards this attractive asset class.

Q: You've mentioned broader sources of income, for example, from European companies as well - can you outline the currency risk of overseas investment and how these risks could/should be managed?

ND: My personal view is that sterling will continue to become a weaker currency over the next five years as we recover from this recession. European investments benefit from a strong currency and stronger government financial positions and therefore investors will not lose from the depreciation of the currency.

Many funds can hedge the currency exposures but over the last year everyone in the UK has found Europe increasingly expensive, while Europe is finding the UK increasingly attractive.