The Search for income in a low interest environment

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There have been some outstanding improvements in UK dividend payouts (but for BP), and the outlook remains positive. How does this square with the economy as a whole and the relatively poor growth performance from key companies?

Interest rates are predicted to stay low for a considerable time and many clients are asking ‘How can I sustain my income whilst protecting the value of my capital over the long term?

In October last year Ward Goodman Wealth Management moved many of its client portfolios into the ‘Global Equity Income Space’.

Ward Goodman anticipated that many more people would start to use equity income to protect the long term value of their portfolios. These ‘equity income shares are often large company shares that deliver a sustainable income and reinvest some profit for future growth. Companies such as Tesco, Halma, Nestle, Coca Cola or Walmart have increased their dividend every year for the last 25 years. They often don’t have significant borrowing AND many have exposure to the emerging markets which we see as a safer route than investing directly into the more volatile emerging market sector.

To hedge against risks such as BP and the loss of a single dividend many clients use a vehicle such as a Unit Trust managed by a fund manager that holds between 50 to 100 of these types of shares so as to smooth the income and return over the long term.


As an example in the UK there are some very rare opportunities amongst high yielding, defensive shares but why have they been overlooked?

Many of these same shares are yielding more than their corporate bonds. Why? Is the outlook for these stocks so poor? Have a look at the table. Why not take the 6% yield from Vodafone and ignore the capital volatility? Couldn’t an institution more concerned about long term cash flow do just that? Since the lows in March 2009 the UK stock market is up 53% (more in the US), an extraordinary rise over such a short period. Over the same period Glaxo is up just 15%, Vodafone by 28%.

We believe that it will not be obvious we are in a new long term bull market until the buying spreads out across the stock market. That isn’t happening. Pension funds have been dis-investing from equities for years (compelled by regulations), and retail and institutional buyers have chased corporate bonds (hence the yields shown in the above table). And trading in the stock market is increasingly dominated by short term "investors" chasing more volatile stocks. That is why the defensives are still offering “rare opportunities”.

The opportunity is even better if you look globally. The prospective price earnings ratio for stocks held by these global income funds are often 30% cheaper than for the MSCI UK Yield index, with more substantial dividend cover and profit margins, and a prospective dividend yield of 4.3%. And there is considerably more choice. At some point there will be a global reallocation from bonds to equities, particularly high yielding equities, but it is not clear when, or that it will be very soon.

At the moment Gilt and Treasury markets are sending out a very cautious message, with yields below those plumbed midst the extraordinary volatility of late 2008. Deflationary signs are clear in the US and China is slowing; we should not get distracted in Europe by a summer lull in the sovereign debt crisis and positive news flow. If we get the slowdown in the second half of 2010 and into 2011 which Gilts/Treasuries appear to be anticipating, a re-emergence of risk aversion will likely push bond yields even lower. In that same, increasingly nervous environment, stock markets should fall and dividend yields rise.

At some point this tendency will reverse and do “the obvious” and buy high yielding equities in increasing volume. We just don’t know when.

To find out more about any of these stories or Ward Goodman please contact 01202 875900