Investing for income. A guide for UK investors. The Merchants Trust PLC

Transcription

1 Investing for income A guide for UK investors The Merchants Trust PLC INVESTING INVOLVES RISK. THE VALUE OF AN INVESTMENT AND THE INCOME FROM IT MAY FALL AS WELL AS RISE AND INVESTORS MAY NOT GET BACK THE FULL AMOUNT INVESTED.

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3 Investing for income a guide for UK investors Introduction For many people seeking to generate income from their savings, the last few years since the financial crisis have been a major challenge. Interest rates on savings accounts have plummeted. The UK recently entered its fifth year with the bank base rate at 0.5%. Some canny savers have managed to eke out better rates by moving their money around between accounts but the situation has not been easy. Initially, government and corporate bonds offered a useful alternative but the overwhelming demand for these securities has driven prices up and yields down and there is concern about what will happen when interest rates eventually start to go up. Investors in shares have generally fared much better thanks to rising company dividends. Although some companies had to cut back their payouts after the crisis, dividends as a whole have risen in recent years. As well as offering investors access to a portfolio of potential dividend-paying shares, investment trusts possess certain benefits that can prove benefical to the income investor. This guide explores the different options available for generating an income from savings and aims to explain the potential advantages of investment trusts. 1

4 Investing for income a guide for UK investors Income choices There are several ways in which capital can be used to generate income. Each has its pros and cons and for most people the ideal solution, where possible, is to spread money among several different types of investments, providing a balance. Banks and building societies Savings accounts have traditionally been a clear favourite for many people who reply on the interest payments as a supplementary income. Deposits are seen as a secure option because the monetary value of savings does not go down and there is protection under the Financial Services Compensation Scheme for deposits up to 85,000 in any one institution should they not be able to meet their commitments. However, interest rates fluctuate so the income from savings accounts cannot be relied upon to remain stable. Not only do the returns depend upon the general level of interest rates but banks and building societies are also able to apply their own discretion to the interest they pay on their accounts. Rates are often inflated by introductory bonuses which then fall away. Inflation can also erode the value of cash on deposit. Property In recent years, many investors have entered the buy-to-let market, buying residential property that they then let out in order to generate a rental income. There has been a growing demand for rented property as the cost of housing has risen. Many investors have profited from this activity, although property is not as liquid an investment as some others. There is also the risk of vacant periods between lets without income and the ongoing costs of maintaining the properties. 2

5 Fixed income securities/bonds A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer. Governments and corporations issue bonds when they need to raise money. An investor who buys a bond is lending money to the government or corporation. Like a loan, a bond pays interest periodically and repays the principal at a stated time, known as maturity. Certain government securities are regarded as the most secure, though corporate bonds can pay higher rates of interest depending on the deemed creditworthiness of the issuing companies. Over the long term, shares have tended to provide a greater total return but bonds are generally regarded as less risky. In the event of bankruptcy, a bondholder will get paid before a shareholder. Equities/shares Purchasing shares in companies listed on the stock market makes an investor a part owner in that company. Shareholders are entitled to receive a share in future profits. Profits are distributed to shareholders in the form of dividends, which are typically paid out half yearly. Yields on shares in 2014 are expected to average around 3.5% net of basic rate tax. Many people consider shares risky because of price fluctuations, which can be significant over the short term, but historically share prices have tended to rise over the longer term. Individual companies may choose not to pay a dividend or could even go bust, which is one reason why many investors prefer to spread their risk by using investment trusts or funds which hold diversified portfolios of shares. 3

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7 Investing in the stock market There are many reasons why investing in the stock market can be beneficial for income investors Higher yields A major attraction at present is that investors can receive a higher income from shares than from deposits. Many large household name companies, such as Legal & General, Imperial Tobacco, GlaxoSmithKline, National Grid and Tesco, have yields of over 4%. Inflation Investors need a rising income if they are going to be able to keep up with rising prices. Well-run companies are able to increase the prices of their goods and services over time or cut costs in order to preserve or improve their profit margins. This enables them to maintain and increase their dividends in line with or in excess of inflation. Access to different types of companies Investors can buy shares in many different industries and market sectors, making it possible to gain exposure to companies in whichever areas of the market they favour. Potential for limiting risk When buying shares, of course there is a risk that companies can be hit by hard times, share prices go down, dividends be cut back or businesses even go bust. However, these risks can be limited by investing through an investment trust or fund which holds diversified portfolios of shares managed by a professional investment manager. Managers will seek to avoid troubled companies but even if one or two have problems the effect on the whole portfolio will be very small. 5

8 Investing for income a guide for UK investors Why use investment trusts? If you want to invest in shares for income and would like the benefit of having a professional investment manager make the buying and selling decisions on your behalf, the easiest and most cost-efficient option is to invest through an equity income investment trust or fund. Both hold portfolios of high-yielding shares and make regular income payments to investors either half yearly, quarterly, or in some cases even monthly. Managers of investment trusts and funds aim to pay out increasing incomes and grow investors capital. But investment trusts have the edge because of some distinct differences in the way they are structured. What are the differences between investment trusts and funds? Closed versus open-ended Investment trusts have a fixed amount of capital while investment funds are open-ended which means they expand and contract according to investor demand. Although investment trusts can issue and buy back shares, the stability of their capital base is often seen as an advantage as it means the managers can make long-term investment decisions without having to worry about the need to raise cash quickly if investors suddenly want to withdraw money. Investors in trusts can easily sell their shares if they want to cash in. Pricing The price of investment funds is determined by the value of the underlying investments. The price of investment trust shares depends on investor demand which means there may be times when the share price is higher (at a premium) or lower (at a discount) than the value of a trust s investments (the net asset value). Nowadays, most trusts have mechanisms in place to ensure that prices do not get too far out of line with the net asset value. For long-term investors in trusts, these differences have relatively little impact. Gearing Unlike funds, investment trusts can borrow money. This can be a mixed blessing. If markets are rising it can provide investors with enhanced rewards, but if markets are falling it can exaggerate falls. Over the long term, however, stock markets tend to rise so gearing can work to the advantage of investors. Boards Funds are run by management companies which appoint investment managers and decide strategy. Investment trusts have their own independent boards of directors who represent the interests of the shareholders. They hold the investment managers to account and, if they are not satisfied, can replace them. History Investment trusts are over 100 years old. Many early trusts are still around and have shown how resilient they are by navigating their way through very difficult market conditions. Investment funds started in the 1930s but they tend to be constantly changing so there is less continuity. INVESTING INVOLVES RISK. THE VALUE OF AN INVESTMENT AND THE INCOME FROM IT MAY FALL AS WELL AS RISE AND INVESTORS MAY NOT GET BACK THE FULL AMOUNT INVESTED. 6

9 The crucial difference for income investors For income investors possibly the most crucial difference between funds and investment trusts is how trusts are able manage their dividends. Investment trusts have a structural advantage which allows them to allocate up to 15% of their investment income in good years to a revenue reserve. The huge benefit of having these reserves is that trusts can draw on them to help smooth out their own dividends during periods when the companies they invest in may be finding it difficult to keep up their dividend payments. Investment funds, on the other hand, are required to pay out all of the income they receive from their underlying investments in the year that it arises so if dividends fall their income payments will have to follow suit. A history of dividend increases It is often stated within the investment objectives of investment trusts that their aim is to pay a rising dividend to shareholders each year. These are not just empty words as the record of many trusts show. The investment managers who run the trusts portfolios look to invest in companies which they believe will generate increasing earnings and pay a growing dividend each year so that they can pass the income on to their own investors. If they detect danger signs that a company is likely to cut its dividends they may sell up and find what they consider a more reliable dividend payer. But unforeseen events can occur, such as the global financial crisis or the BP Deepwater Horizon oil spill, which can also result in some companies cutting their dividends. In this type of situation, managers have the option of dipping into their revenue reserves in order to maintain or increase their own dividend payout. The skill of investment trusts in managing their dividend flows is proved by the Association of Investment Companies (AIC) 2014 dividend survey. It shows that among all the AIC members which are at least ten years old, almost a quarter (24%) have been able to increase dividends for each of the last ten years. This is particularly impressive considering that this period includes the financial crisis of An elite group of fifteen investment trusts, which includes The Merchants Trust, have increased their dividends for thirty years or more. 7

10 Investing for income a guide for UK investors The UK for income Among income producing investment trusts and funds, some specialise in investing in UK companies while others invest overseas, either in specific countries or regions or globally. For UK based investors, whose outgoings are in pounds sterling, it usually makes sense to have their core holdings in UK investments. For one thing, it helps to reduce currency risks whereby dividend payments can be affected by fluctuations in exchange rates through no fault of the investment managers. Another advantage of investing in UK companies are the high standards of corporate governance. UK companies are also very shareholder aware and tend to have progressive dividend policies, placing considerable importance on increasing their payouts to their shareholders. Investing in UK companies does not mean that investors are only exposed to the UK market place either. Many UK companies of all sizes provide goods and services to other countries, so investors also gain exposure to the global economy. 8

11 T H A N NI V E R S A R Y The Merchants Trust PLC The Merchants Trust was founded in 1889 by some of the leading financiers and lawyers of the day. The founders of the trust wanted to give it a strong identity and its name derives partly from the firm which set it up, Bensons, who historically had been merchants themselves T H A N N I V E R S A R Y Initially the trust invested internationally, putting up money for the building of railways in North America and Africa, as well as into other types of commercial ventures such as breweries. It also held government bonds. This diversification served it well during some difficult times including the two World Wars and the Wall Street crash. From a very early stage, Merchants also started doing what it has become so good at - paying regular, increasing dividends to its shareholders. During its first 50 years up to 1939, it paid average annual dividends of 7.5%. By the mid 1950s, as equity investment became increasingly popular, Merchants portfolio was largely invested in shares. In 1960, its parent company merged with banking group Kleinworts to become Kleinwort Benson. By 1962 its assets had reached nearly 18m and by the end of the sixties, after some extra fund raising, they had risen to 45m. The UK stock market had a particularly difficult time in the mid 1970s but recovered sharply thereafter. Around that time, Merchants was to benefit from the success of its early holdings in the North Sea oil industry. Between 1975 and 1985, its assets, having dipped back to 31m, grew to over 127m. In 1984 the trust adopted the formal objective of providing a high and growing income without materially impairing the prospects for capital growth. It has achieved this goal with distinction. By 2014, it had achieved 32 consecutive years of dividend growth helped by its ability to put reserves aside in the good years that could be used on rainy days when the companies it invested in were struggling. Since the late 1980s the company s investment universe has been primarily high yield, blue chip UK companies in the FTSE 100 Index. In 1995 Kleinwort Benson was acquired by Dresdner Bank which was in turn taken over by Allianz in The Merchants Trust, which recently celebrated its 125th anniversary, is today managed by Allianz Global Investors. Its assets are now worth 670m. From left to right: Simon Fraser, Chairman, and board members Mike McKeon, Paul Yates and Henry Staunton. 9

12 Investing for income a guide for UK investors The investment manager The manager of The Merchants Trust is Simon Gergel, Allianz Global Investors Head of UK Equities, who has run the portfolio since He has the responsibility for deciding which shares to buy and sell in order to maintain the trust s rising income. Gergel explains some of his criteria for deciding which shares to buy: The dividend must be at least in line with the market or expected to be there within 18 months. However, dividend yield is not the only reason I buy or sell a stock. I look for companies with strong cash flows and good fundamentals. I look at their balance sheets and management and I also look to pay a reasonable price for the shares. I look for companies with strong cash flows and good fundamentals Gergel says that he has never struggled to find shares with adequate yields. He believes investing in these stocks is a good discipline. He points out Research has shown that, on average, higher-yielding shares outperform others over the long term. One of the reasons for this it that looking for higher yields encourages investors to be contrarian, Gergel explains: It means I tend to buy shares when they are cheap and out of fashion. When share prices rise, it gives the trust s capital value a boost. Although Gergel is primarily looking for good companies with reliable cash flows that enable them to pay dividends, he also considers various investment themes and economic factors when choosing his investments in order to take advantage of market trends. This enables him to invest for the long term and future-proof the portfolio. Unlike his predecessors of a hundred years ago or some competitors today, he doesn t hold vast numbers of shares in the portfolio. He points out Diversification doesn t necessarily reduce risk and the large companies we hold are themselves trading around the world so we get diversification that way. 10

13 Contact us When it comes to deciding on the dividends to be paid to shareholders in Merchants, Gergel says it is the trust s board which has the final decision. He points out the trust s reserves meant that it was able to continue increasing the dividend even after the financial crisis resulted in some of the companies it invested in having to cut theirs. Now Merchants dividend is covered again and it still has a year s worth of dividends in reserve for future smoothing. I expect flat or modest growth in dividends this year but better growth from next year For further information on The Merchants Trust, please call or . Alternatively, why not visit our website? You ll be able to hear portfolio manager Simon Gergel s thoughts on current opportunities in the UK stock market, learn more about the experienced Merchants Trust board, and view the Trust s dividend history investment-trusts@allianzgi.com website: Gergel believes the general outlook for UK dividends is positive. He says Companies have rebuilt their balance sheets although the flip side is that the strength of the pound is reducing cash flow back to the UK. I still expect to see flat or modest growth in dividends this year but better growth from next year. Opinions as at July How to invest The Merchants Trust PLC is a UK-based investment trust traded on the London Stock Exchange. You can easily invest in the Trust by purchasing shares through a stockbroker or an investment platform. You can also hold shares within an ISA, SIPP and/or savings scheme. For a list of stockbrokers and investment platforms through which you can buy shares in The Merchants Trust, please visit or call

14 Investing for income a guide for UK investors Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors may not get back the full amount invested. Past performance is not a reliable indicator of future returns. You should not make any assumptions on the future on the basis of performance information. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer and/or its affiliated companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. This is a marketing communication; issued by Allianz Global Investors Europe GmbH, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, D Frankfurt/Main, registered with the local court Frankfurt/Main under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht ( Allianz Global Investors Europe GmbH has established a branch in the United Kingdom - Allianz Global Investors Europe GmbH, UK branch - which is subject to limited regulation by the Financial Conduct Authority ( The Merchants Trust PLC is incorporated in England and Wales. (Company registration no ). Registered Office: 199 Bishopsgate, London, EC2M 3TY. The Company is a member of the Association of Investment Companies - Category: UK Equity Income. 12

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16 The Merchants Trust PLC 199 Bishopsgate London EC2M 3TY T: +44 (0)