EquitiesMar 23 2012

Equity income: Coming of age or hanging its boots?

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Following a flurry of fund launches in 2011, a new Investment Management Association (IMA) sector, Global Equity Income was launched on 1 January 2012, currently totaling £3.8bn.

However, there are those who argue that the strategy is a fad and, much like last year’s fashion purchase, in the cold light of the new season it is unlikely to shine. But lessons from history and thoughts for the future both suggest that equity income strategies can provide an attractive long term investment story.

The new IMA sector could not highlight this for investors at a better time. Equity income can provide an elegant solution for the new demographic of an increasingly ageing world. Rather than hanging up their boots and switching their funds to Government bonds on the day they leave work, retirees are faced with the conundrum of living longer in a world where returns are low and Governments are strapped for cash – a situation that may only intensify in the coming years. Retirees, much like global equity income strategies, are coming of age.

Keeping it real

When considering the benefits of equity income investing, it is easy to see why the strategies are proving so popular, and while once firmly the domain of the UK equity market, developments from global markets have permitted a much broader choice.

Low interest rates look set to be a feature of investing landscape in the developed markets for the near future. Combined with above-target inflation and anxious investors, this is making real, sustainable and meaningful income increasingly elusive.

Yields on traditional safe haven bonds and cash are at very low levels and generating meaningful income from corporate bonds means taking on higher and higher levels of risk. Meanwhile, the security of leaving money in the bank is offset by the negligible returns available through cash deposits.

When you think about the long term effect, the numbers are alarming. A traditional balanced portfolio today yields just 3%, compared to 6% 20 years ago – meaning that it would take 23 years instead of 11 to double your money through compounding income alone.

With equity income, dividend payouts are taken from company profits, which can increase over time and are not time limited by maturity date. They are often viewed as an important signal about corporate health, encouraging company management to at least maintain, if not grow, their returns to shareholders.

As a result, equity income investing can offer an indefinite and potentially rising income stream. And it is not just income, it is real income. Inflation erodes the purchasing power of returns on most bonds and on cash.