In the sector press
Hungry for income
Kate Rogers, Portfolio Director and Head of Policy at Cazenove Charities shares her thoughts on issues faced by the charity sector in Third Sector Magazine every other month.
Why invest? Obvious, perhaps - we invest our hard earned pennies to make them go further. To grow the capital value of them for tomorrow and to generate an income for us to spend today. However, those of us with more of a focus on the income flow have been challenged in recent years, as interest rates remain stubbornly low and yields on bonds continue to fall. For some time, 'safe' investments have not been generating much income.
It all began with the credit crisis. The Bank of England (and other central banks) had to act to keep the monetary cogs turning, both by cutting interest rates to historic lows and by printing money to buy government bonds, so called Quantitative Easing. And it appears to have worked. We are still here, with a functioning banking system and talk of the government's stake in Lloyds being sold back to the public. It seems almost unbelievable to us today that the UK base rate stood at 5.75% p.a. in July 2007. Roll forward just 2 years and it had fallen to 0.5%, where it remains today.
This has had wide ranging, and perhaps unintended, consequences. Investors looking for income have flocked to riskier assets, such as property and equities. Property has attracted charities to income yields of over 5% per annum. The Charities Property Fund has recently announced that it has passed £1bn under management, a doubling in 2 years.
Within equity markets, income biased investments have been favoured and demand for income producing products has been ever increasing. Investor demand is even changing corporate behaviour as executives choose to pay out earnings as dividends, rather than reinvest them into their businesses. The UK equity market payout ratio is 20% higher than pre-crisis levels, which could be a concern for long term investors, as reinvestment is needed to lay foundations for the future.
A charity investing in the UK equity market will, today, get an income of about 3.5%. This represents approximately 50% of total UK listed corporate earnings, although that varies by sector. Technology companies tend to pay out less and reinvest more into their businesses, and there are now significant challenges for the oil and gas sector, whose historic dividend payments may well exceed their earnings because of lower commodity prices. Investing for income must look forwards as well as backwards.
Interest rate increases in both the US and UK are on the horizon. If investment markets were driven up by interest rate falls, will the reverse be true? Rate rises will gradually improve the return on cash deposits, but will threaten bond investors as increasing yields translate to falling prices. Corporates may feel the pressure on profit margins but rate rises are unlikely to halt the hunt for income in equity and property markets, as the gap in yield is so wide.
What does this mean for charities that need to balance the needs of today against the requirements of tomorrow's beneficiaries? Long term charity investors with income requirements will probably be biased towards equity and property markets. These investments are likely to generate a better return over the long term and a higher income today. However, the cost of this opportunity is larger oscillations in value. Not necessarily a concern for the long term investor, but charities need to have the governance in place to support this strategy. Equity market volatility has risen over recent months, and the eventual increase in US and UK interest rates is likely to perpetuate these oscillations.
A version of this article first appeared in Third Sector in October 2015. For this and other articles by Kate Rogers, visit thirdsector.co.uk
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