As interest rates remain at historically low levels, pension savers looking for a return on some or all of their cash lump sum could find themselves joining the so called ‘hunt for income’, which has been pushing income seekers towards equities in their pursuit of higher yields.
There are a wide variety of assets and investment vehicles available for those looking to generate a higher income than can be gained from cash alone.
One investment vehicle which is often overlooked but could make a positive difference to the size of a pension pot is the investment trust.
Investment trusts can offer significant long-term track records of dividend increases. A fifth of conventional Association of Investment Companies member investment trust companies which have been in existence for more than 10 years have raised their dividends for at least each of the last 10 years.
Some, like The Scottish Investment Trust Plc (SIT), have more than 30 years’ unbroken record of dividend increases, according to AIC data for March 2015. In fact, SIT has either increased or maintained its dividend every year since the Second World War.
Investment trusts with long-term consecutive dividend increases are dominated by the Global and the UK Equity Income sectors which yield on average 1.8 per cent and 3.6 per cent respectively, according to dividend yield data collected from the AIC as at 31 July 2015.
Whether you are looking at the long-term or at higher yields, a key to income return is the reinvestment of dividendsIt is in the less traditional investment sectors that higher investment trust dividend yields tend to be found. Of the 55 investment trust companies with a dividend yield of over 5 per cent, almost three quarters (73 per cent) invest in specialist sectors such as direct property, infrastructure and debt, according to dividend yield data collected from the AIC on 31 July 2015.
Although these specialist sectors can offer opportunities for higher levels of income, they tend to be higher risk as assets held are often illiquid, ie cannot be easily or quickly sold, and income-generating niche investments can be subject to sector-specific risks, with potentially more volatile investment performance as a result.
However, for investors who are prepared to accept these risks for the potential income reward, investment trusts can provide a flexible and liquid way of holding high income but illiquid assets.
Their closed-end structure allows investment trusts to invest in the type of illiquid assets that other investment vehicles may find difficult to hold because, unlike unit trusts or open-end investment companies (Oeics), the managers of investment trusts don’t need to buy and sell holdings to accommodate the (often unpredictable) movements in fund size which result from investors buying into or selling out of an open-ended fund.
Another unique feature of investment trust companies is their ability to hold back income in reserves. These reserves can then be used to help smooth dividend payments over more difficult years with the aim of producing a more stable income stream and potentially avoiding dividend cuts.
Whether you are looking at the long-term or at higher yields, a key to income return is the reinvestment of dividends. Investors who reinvest their dividend income will see the combined benefits of pound cost averaging (most particularly in volatile or falling markets) and of compounded growth – the latter most especially in buoyant or rising markets.
Taking SIT’s period of dividend increases as case in point, £1,000 invested into SIT on 31 July 1984 would have been worth £9,653 in capital terms (through growth in share price) on 31 July 2015. However, if dividend income had been reinvested, the value would be well over double that at £21,292 (Source: Thomson Reuters Datastream).
It must be remembered that past performance may not be repeated and is not a guide to future performance. The value of stockmarket investments and the income from them can go down as well as up and investors may not get back the amount originally invested.
Finding income to replace an annual salary is likely to be a top priority for anyone entering retirement, whether they are interested in investing their pension cash or purchasing an annuity. But with the freedoms now available to pensioners, the risk versus potential reward calculation has just got even more complex.
Sherry-Ann Sweeting is marketing manager of SIT Savings Ltd on behalf of The Scottish Investment Trust.
